Chapter 7 bankruptcy is the most common. In simple terms, it is a process that allows you to get rid of most of your debts…but you have to give up some of your assets in return. In more legal terms, a court appointed trustee gathers all your assets (items of ownership convertible to cash), sells them and distributes the money to your creditors.
Chapter 13 bankruptcy is for people who are earning a steady income, whether it be through employment, their retirement pension, etc. and are unable to pay their debts. The courts will execute an agreement that will require you to pay back a portion of your debts over a period of time.
Many people that ask the question “What’s the difference between Chapter 7 and Chapter 13 bankruptcy?” are actually asking “Which one is better?” In reality, the question should be “Which one is less worse?” as either option is difficult…emotionally, psychologically and financially. There are pros and cons either way and you must determine which is best for you.
The advantages of Chapter 7 bankruptcy is that it is faster and gives what some people perceive as a “new beginning”. This is true, but your “new beginning” might be dramatically different than you anticipated. It will not be the financial life you lived before as you may have to sell assets to pay your creditors.
There are many disadvantages to Chapter 7 bankruptcy. It is important to understand that not all of your debts will be discharged under Chapter 7. Debts that are non-dischargeable, such as a student loan, will not be discharged. Secured debts, such as an auto loan, may not be discharged. There is the possibility that a debt may not be discharged if there is suspicion that you tried to commit fraud. Many people that have decided to file for bankruptcy have run up their debts and bought furniture or a new car, waited a few months, then filed trying to get that debt discharged. That’s a dangerous legal game and you could not only owe the debt anyway, but may receive fines or jail time for attempting such actions. The moral character of someone who would do this is not the type or person for this site, so if that is your intention, please find somewhere else for your information.
Another disadvantage is obviously the destruction of your credit. This is repairable, but be prepared for a long journey back to credit worthiness. Oddly enough, you may find the process rewarding as you learn about financial responsibility and how it affects all aspects of your life.
The advantages under Chapter 13 bankruptcy is that you get to keep all your property and only restructure the debt. You cannot be foreclosed on so you will be able to keep your home and you will have more time to pay back your debts than under Chapter 7.
The disadvantages are that there are caps on the amount of personal debt you can claim. These amounts change and are generally larger than most middle class families have in debt, but be sure to check into the current caps. As mentioned elsewhere on this site, I resist giving amounts that are constantly in flux as I could easily miss an update to a previous article resulting in bad information being passed. I would rather you look up the current information at the time you are considering this process.
Another disadvantage to Chapter 13 bankruptcy is that it ties up your income for the amount of time agreed upon. This could be many years. If you move or change jobs and your income changes, your debt restructuring does not change with your circumstances. Decisions may have to be made in your life around the legal repayment plan.