Bankruptcy Basics – Chapter 7 vs. Chapter 13

I’m writing this article as an experienced Pennsylvania bankruptcy lawyer to provide you with an outline of the basics of bankruptcy and to answer some common questions.

What Kind of Bankruptcies Are There?

The two types of bankruptcy most commonly filed by consumer debtors are called “Chapter 7” Bankruptcy and “Chapter 13” Bankruptcy, after the Bankruptcy Code sections where the applicable law is found.  Whether to file under one Chapter or the other depends upon several factors, including your current income, the value of your assets, and your goals in filing a bankruptcy petition.

How Does Chapter 7 Bankruptcy Work?

If you file your bankruptcy petition under Chapter 7, you have passed the “means test” (an evaluation of your debt and your income and family size in relation to the median income for your state).  Your attorney will help you determine whether you qualify to file Chapter 7 – extraordinary medical, commuting or childcare expenses can also factor in and render you eligible to file even if your income is above the median for your family size. 

Procedurally, a bankruptcy case is commenced when one files a “petition.”  Once the petition is filed, the “automatic stay” goes into effect, which stops or “stays” collection actions against you, including lawsuits.  When you file your petition, you will also file “schedules” in which you set forth your personal information and your debts, your income, your expenses, and the nature and value of your possessions and assets. 

Your assets, less some “exemptions,” constitutes your Bankruptcy “estate.”   The estate is administered by a Trustee.  The Trustee will meet with you and your attorney at the “341(a) hearing” to establish your identity and verify facts set forth in your petition and schedules, and to make further inquiries if warranted.

If you file Chapter 7 bankruptcy, you can expect to receive a “discharge” of unsecured debt within four to six months from filing, barring complications, and then your case will close, giving you your fresh start.

How Does Chapter 13 Bankruptcy Work?

If instead of filing a Chapter 7 petition you have filed your petition under Chapter 13, you will have experienced much the same procedure as if you had filed under Chapter 7, and also you will have filed a proposed repayment “plan” lasting three or five years.  You will commence making monthly plan payments to the trustee, who will, in turn, make distributions to your creditors in order of priority as set forth in that plan. 

When all plan payments have been made, your Chapter 13 plan is completed and you will receive a discharge as to that portion of unsecured debt which was not be paid through your plan.

As you might imagine, there is much to consider in determining whether Chapter 7 or Chapter 13 filing is appropriate for you. You should meet with a qualified bankruptcy attorney before making the decision.

I’ve heard that the Trustee can seize my assets if I file Chapter 7 – is this true?

The short answer is yes, Trustees have the power to seize assets that are not “exempt” from the bankruptcy “estate” (all of your assets and possessions). Your attorney’s job is to make sure all of your assets are protected from seizure by fully utilizing all “exemptions” (statutory means of taking assets/possessions out of the estate) available under the law. 

Be aware that, to the extent your estate exceeds your allowable exemptions, the Chapter 7 trustee may liquidate (sell) and distribute that portion of your estate to your creditors.  This can be problematic if, for example, you have equity in your home or car; in other words, if your home or car are worth more than you owe on them. 

One of the purposes of your initial consultation with your attorney is to determine whether any of your assets are at risk of sale by the Trustee.  If so, and you want to retain possessions that are non-exempt and/or in which you have equity, Chapter 7 may not be right for you and your attorney will help you explore your other options, including Chapter 13.

Is Debt Settlement Better than Bankruptcy?

No, unless you have only one or two creditors and those are willing to negotiate with you.

You should know that no creditor is required to negotiate with you outside of bankruptcy. Each of your creditors is entitled to be paid in full per the terms of their contracts with you, and creditors have little incentive to negotiate with you unless the law intervenes somehow. Filing a bankruptcy petition is the only sure way to stop collection efforts and force creditors to the table.

Can Bankruptcy Help Me With Student Loan Debt?

Bankruptcy will probably not help you with student loan debt unless they are private loans.  Consult with your attorney about whether your student loans qualify for discharge.

There are programs available through your loan servicer that can help you temporarily postpone or reduce your student loan payments.  For example, a deferment is a period of time, usually a year, during which your payments are temporarily postponed.  However, interest continues to accrue on unsubsidized loans and maybe capitalized, i.e., added to your principal balance, therefore, while loan deferment may provide you with temporary relief, it may also increase your overall debt. 

Forbearance can also eliminate or reduce your monthly payment temporarily.  There are two types of forbearance:  mandatory and discretionary.  You may ask your lender for discretionary forbearance due to financial hardship or illness.  Mandatory forbearance is granted when certain conditions are met, among them whether your student loan payment is twenty percent or more of your gross monthly income.

It is important that you avoid defaulting on student loans in order to remain eligible for programs such as these.  If your unsecured or medical debt burden is compromising your ability to pay your student loans and your monthly expenses, perhaps debt consolidation or bankruptcy can help you.

What Does Filing Bankruptcy Do To My Credit?

While it is true that a bankruptcy filing can remain on your credit report up to ten years, many debtors find that after they receive their discharge their credit scores rise because their debt-to-income ratio has dramatically improved. 

After receiving a discharge of unsecured debt, you can and should go about repairing your credit by paying all bills, such as student loans, utilities, rent or mortgage, and car loan or lease, on time and in full.  This way, if you need to borrow money in the years following bankruptcy you can show the lender a positive payment history after bankruptcy helped you achieve a fresh start.

About the author:

David M. Offen, Esq.

Mr. Offen is a Philadelphia bankruptcy attorney who attended Temple University College and Law School. Mr. Offen is licensed to practice in the States of Pennsylvania and New Jersey. He is a member of the Eastern District of Pennsylvania Bankruptcy Conference and the National Association of Consumer Bankruptcy Attorneys and maintains an active blog on all aspects of bankruptcy filing and current events.

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