Simple and Not-so-simple Debts in Chapter 7 and 13

Very broadly speaking Chapter 7 handles simple debts as well or better than Chapter 13 does, which handles more difficult debts better.

Debts in Bankruptcy

When deciding between Chapter 7 “straight bankruptcy” and Chapter 13 “adjustment of debts” you look at many factors. You have to meet certain qualifications (usually easy to meet) to file either one. The amount of your income, the nature of your assets, whether you own a business, and your immediate and long-term goals—all of these come into play.

But the most important consideration is your debts. Bankruptcy is of course mostly a tool for dealing with your debts. Chapter 7 and Chapter 13 each deal better than the other with certain types and combinations of debts.

Today we get into which of these two consumer bankruptcy options is better for which debt scenarios.

A Helpful Starting Point

Our first sentence gives us a good starting point. Chapter 7 handles simple debts as well or better than Chapter 13 does, which handles more difficult debts better.

So if you have mostly or all simple debts, then Chapter 7 will tend to be better for you. If you have a number of difficult debts, Chapter 13 will more likely be better.

The Different Types of Debts

There are basically three types of debts:

1. General unsecured—There’s no collateral or “security” tied to these debts (“unsecured”), and they aren’t “priority”—given special treatment in the law. General unsecured debts include most credit cards, medical debts, no-collateral personal loans, utility bills, back rent, and many, many others.
2. Secured—The debts are legally tied to collateral or with a lien on something of value. Included are home mortgages, vehicle loans, retail debts secured by the goods purchased, personal loans secured against personal possessions, business loans secured by business and/or personal assets—all debts secured by anything you own.
3. Priority—Simply, debts that the law treats as special for whatever policy reason. The main examples for consumer debtors are recent income and other taxes, and child and spousal support.

These different types of debts are treated differently in Chapter 7 vs. Chapter 13.

Debt Scenarios Handled Well by Chapter 7

If ALL your debts are general unsecured debts, Chapter 7 will more likely be your better option. Most general unsecured debts are discharged—legally written off—in a Chapter 7 case. So you file a Chapter 7 case through your bankruptcy lawyer in usually less than 4 months all your debts are discharged. You have your fresh financial start.

Some secured debts are handled reasonably well in a Chapter 7 case. If you are current on a home mortgage or vehicle loan, you can usually keep your home or vehicle by maintaining your payments and “reaffirming” the debt. If you are very close to being current, you may be able to catch up and “reaffirm” as well. If you are surrendering a home or vehicle (or any other collateral) Chapter 7 often works well for that.

Chapter 7 may be appropriate for dealing with certain limited priority debts. If you owe an income tax debt or are behind on child support, discharging all or most of your other debts may enable you to catch up on the tax or support. But you are subject to collection actions by the tax authorities as soon as your Chapter 7 is over. And as for support debt, a Chapter 7 filing does not stop its collection even while your bankruptcy case is active. So if you owe any tax debt that you can’t comfortably pay through a standard IRS/state payment plan, Chapter 13 may be the better option. And if you are behind on child or spousal support, only Chapter 13 can stop the aggressive collection actions that an ex-spouse or support collection agencies can use against you.

Debt Scenarios Not Handled Well by Chapter 13

If ALL your debts are general unsecured debts, Chapter 13 is usually not your better option (assuming you have a choice). That’s because unlike Chapter 7, in a Chapter 13 case you usually have to pay a portion of your general unsecured debts. You pay as much of those debts as you can afford to do so over a 3 to 5-year period. Then the portion you did not pay gets discharged.

It’s important to understand that the general unsecured debts are often paid relatively little in a Chapter 13 case. It’s common that you’d pay only 5 or 10 cents on the dollar, and almost always no interest or penalties. In many parts of the country you can even pay 0 cents on the dollar. That’s because the debtor owes secured or priority debts which use up all the money he or she can afford to pay.

Debt Scenarios Handled Well by Chapter 13

Chapter 13 deals with secured debts often better than does Chapter 7. That’s especially true if you’re behind on a debt with collateral you really want to keep. Under Chapter 7 you’d usually have to get current on a vehicle almost immediately to be able to keep it. You have many months—or even a year or two—to catch up under Chapter 13. If you’re behind on your home mortgage you get up to 5 years to catch up.

Chapter 13 also gives you some very powerful tools for dealing with secured debts unavailable under Chapter 7. You may be able to “strip” a second or third mortgage off your home’s title. You may be able to do a “cramdown” on your vehicle loan or other personal property debt, potentially greatly reducing your monthly payment and the total you pay.

With priority debts, Chapter 13 gives you tremendous power and flexibility. It stops collection of support arrearage, and gives you months or years to catch up—as long as you keep current on ongoing support. With unpaid income taxes Chapter 13 provides many benefits. It prevents future tax liens. It enables you to deal with prior-recorded tax liens extremely well. Chapter 13 gives you up to 5 years to pay taxes that can’t be discharged. Usually throughout that time you pay no ongoing interest or penalties.

Conclusion 

It’s a bit of an oversimplification to say that simple debts lead to Chapter 7 while more complicated ones lead to Chapter 13. But, as we’ve just shown, that’s often the situation.

But just as you are a unique human being, your circumstances are unique. Get the unique assessment of your options that you need from an experienced and empathetic bankruptcy lawyer.