When To Consider Filing Under Chapter 13 Instead of Chapter 7

Chapter 13 can help manage debt. Getty Images

Why would someone want to file a Chapter 13 case that requires them to make monthly payments? Wouldn’t it make more sense to file a Chapter 7 case, make no payments (or give up only a small amount of property) and get a discharge in six months?

That’s a legitimate question. Chapter 13 accomplishes different goals for individuals than they can get in a Chapter 7 straight bankruptcy. There are several reasons why a Chapter 13 would be more appropriate for some people than a Chapter 7.

Here are the main reasons to file a Chapter:

You can’t pass the Means Test

In 2006, Congress enacted the current version of the federal bankruptcy laws. In the Bankruptcy Abuse Prevention and Consumer Protection Act, Congress attempted to design the bankruptcy process to funnel more people into a Chapter 13 case, and thereby encourage more payment of more debt. In other words, BAPCPA made it harder for people to qualify for a Chapter 7 liquidation and encouraged those who take advantage of a Chapter 13 repayment plan to devote more of their future income to paying down their debt.

Individual debtors qualify to file a Chapter 7 case by passing a Means Test, which is a series of calculations taking into account your income and many of your expenses. The higher your income (or the lower your expenses), the more likely you will not pass the Means Test.

If you don’t pass the Means Test, you may still be able to file a Chapter 7, but more likely your only option will be to file a Chapter 13 case and set up a plan to make monthly payments to repay a portion of your debt.s

You can learn more about how the Means Test works at The (Can I File Bankruptcy) Means Test.

Your creditor is about to repossess your car or foreclose on your house

If you are behind in your payments on collateral like a house, car or other property, you can pay out either the entire value of the property or just the past due amounts as a part of your Chapter 13 plan over a three to five year period.

You owe taxes to the IRS or to another taxing authority.

A Chapter 13 case may allow you to set up a reasonable payment plan that covers the amount of taxes you owe. While you may be able to do this outside of bankruptcy, if you do it as a part of a Chapter 13 plan, the bankruptcy process will protect you from garnishments, levies and other collection actions by the tax agency - even the IRS - and will allow you a period of up to five years to pay what you owe.

You don’t want to give up your nonexempt property.

In Chapter 7, you are allowed to keep a certain amount of property so that when the bankruptcy is over you will still be able to live your life and support your family. This is called exempt property. If you have property that is not exempt, you are required to turn that over to a trustee who sells it and uses it to pay at least a portion of your unsecured debts, like credit cards, medical bills and personal loans.

In a Chapter 13, instead of turning over the nonexempt property, you agree to make payments over the life of your plan that will pay your unsecured creditors at least as much as they would receive in a Chapter 7 case. Chapter 13 keeps you in control of your assets. For example, let’s say you own some stock in Exxon.

It’s worth $2,000 now, but you think it will be worth more later, and you want to keep it as an investment. In a Chapter 13 case, you keep the stock, but propose a payment plan that will allow your creditors to receive at least $2,000.  This is called the Best Interest of Creditors Test.

To learn more about saving your property with a Chapter 13, see The Best Interest of Creditors Test.

You want to protect a co-signer.

Sometimes when you take out a loan or an account, the lender will require that you have someone sign with you. This co-signer is as obligated on the debt as you are. If you fail to pay, the lender will look to the co-signer for payment.

If you file a Chapter 7 case, the lender is free to seek payment from the co-signer. But, if you file a Chapter 13 case, your co-signer is protected by law as long as you are making your payments according to your payment plan.

 

 

Whether you choose a Chapter 13 or find that a Chapter 13 is your only bankruptcy choice, you need to understand that a Chapter 13 requires discipline and sometimes sacrifice. Understanding that up front will increase your odds of successfully completing a Chapter 13 plan. See more at Living With a Chapter 13 Case, Part 1 and Living With a Chapter 13 Case, Part 2.