The Two Types of Personal Bankruptcy

If you’re considering filing for bankruptcy as a way of escaping debt, it’s important that you know as much as you can about bankruptcy before you move forward. Read on to get an idea of which type of personal bankruptcy, Chapter 7 or Chapter 13, would best suit your financial needs.

Chapter 7 Bankruptcy, or “liquidation,” allows petitioners to discharge most unsecured debts.

Chapter 13 Bankruptcy, or “reorganization,” allows petitioners to repay most secured debts over the course of three to five years.

Chapter 7 & Chapter 13: The Similarities

Whether you file under Chapter 7 or Chapter 13 of the Bankruptcy Code, you’ll have to fulfill certain requirements. Before actually filing your petition with the court, you’ll have to complete an approved Credit Counseling briefing. The purpose of the briefing is basically to introduce bankruptcy alternatives (like credit counseling, debt consolidation, etc.) and make sure that bankruptcy is your only viable option.

Then, before you can receive your discharge from the court, you’ll have to complete a Debtor Education course. This course is designed to help you make the most of the fresh financial start bankruptcy offers: it covers topics like budgeting, money management and financial planning.

Automatic Stay

The automatic stay is one of the key protections in any bankruptcy case. As soon as a bankruptcy case is filed, the automatic stay takes effect and prevents ALL creditors from contacting the filer. The automatic stay often provides bankruptcy petitioners with welcome relief from phone calls, letters and home visits from debts collectors.

Chapter 7 Bankruptcy: “Liquidation”

Chapter 7 bankruptcy allows filers to discharge many unsecured debts. Unsecured debts are not tied to any property and include credit card debt, medical debt and more. It’s sometimes referred to as “liquidation” because the bankruptcy trustee can liquidate, or convert to cash, a filer’s non-exempt assets to pay creditors. We’ll get to that later. Let’s look at some of the details of filing Chapter 7 bankruptcy.

Chapter 7 Means Test

The means test is a qualifying test that a filer must pass in order to be eligible to file under Chapter 7 of the U.S. Bankruptcy Code. It compares your current monthly income to the median income, for a family the same size as yours, in your state. If your income is the same or less than this comparible median income, then you can file for Chapter 7. If your income is more than the comparable median income for your state, you need to go to the second part of the means test to see if it is still possible for you to qualify for chapter 7.

The second part of the means test is more complicated, certain “allowable expences” are subtracted from your income to determine your disposable income. If your monthly disposable income is less than a predetermined amount, then you can file chapter 7.  Your bankruptcy attorney can help you to determine which expensis are “allowable expensis” and if your disposable income still qualifies you to file for chapter 7.

Those who “pass” the means test basically show that they don’t earn enough money to make regular payments in a Chapter 13 repayment plan.

Chapter 7 Timeline

Generally speaking, Chapter 7 bankruptcy cases move quickly and filers receive a discharge in a matter of months. After filing Chapter 7 bankruptcy, you are unable to do so again for eight years. Those who file under Chapter 7 must complete the Debtor Education course fairly quickly, since you’ll be eligible for a discharge in only a matter of months.

Dischargeable and Non-Dischargeable Debts in Chapter 7 Bankruptcy

When you file for Chapter 7 bankruptcy, the court will offer you a discharge from many unsecured debts. Some debts, though, are not eligible to be discharged in bankruptcy. Non-dischargeable debts include student loans, child support, alimony, taxes and criminal fines. Most other unsecured debt is dischargeable.

If you’re interested in keeping property like a home or a car during a Chapter 7 bankruptcy filing, you’ll have to reaffirm your debt with your creditor. It’s best to consult with your bankruptcy lawyer before making big decisions like this.

Chapter 7 Exemptions

As mentioned above, your bankruptcy trustee can sell any of your property that isn’t exempt and use the profits to pay creditors during a Chapter 7 case. Exemptions vary from state to state, but generally include a home, work tools, certain personal belongings, etc. It’s important to discuss this with your bankruptcy lawyer, so you understand exactly what you may be expected to give up.

Most people who file for Chapter 7 bankruptcy don’t have much non-exempt property, and very little actual liquidation usually occurs.

Chapter 13 Bankruptcy: “Reorganization”

Chapter 13 is designed for those with a steady income who are struggling with debt. The goal is to reorganize their debts, and pay them off over a period of three to five years. Chapter 13 bankruptcy can help ease debt for those who have a steady job but face or have faced a temporary financial setback or those who have non-exempt property they’d like to hang on to.

Chapter 13 to Stop Foreclosure

Filing Chapter 13 bankruptcy can be an effective method of stopping foreclosure. Mortgage foreclosure is considered a form of collection, and when the automatic stay takes effect, it halts all collection actions.

Though mortgage agreements cannot legally be altered by a bankruptcy court, filing Chapter 13 bankruptcy often allows petitioners enough breathing room to reorganize finances enough to allow them to make mortgage payments.

Chapter 13 Timeline

Chapter 13 bankruptcy cases generally last three to five years. During that time, petitioners make payments to their creditors according to a repayment plan determined by the court. Those who file under Chapter 13 have much more time to complete the Debtor Education course, but can benefit from completing the course early in the process – the information about money management in the course is valuable for anyone working to pay off debts!

Who Can File Chapter 13 Bankruptcy?

Generally, if you have a source of regular income, can afford the payments outlined by the court and have debt that falls within certain limits, Chapter 13 could be an excellent way of clearing your debts. Chapter 13 cases can also be useful if you have secured property (like a home or car) that you want to hold on to during bankruptcy but might not be able to in a Chapter 7 filing.

The Bankruptcy Means Test

The bankruptcy means test, as it is known, was part of the new bankruptcy laws of 2005. In order to file Chapter 7, you’ll need to pass the means test.
The good news is, the means test is not an actual exam. It is a measurement of “true need,” and a bankruptcy lawyer can take you through the test and, in short order, let you know if you qualify.
Basically, it works by taking into account your income, your debt and the size of your family, to determine if you truly do need Chapter 7 bankruptcy.
This may sound intimidating, but it’s not designed to be the roadblock it may seem. The means test is in place to prevent people from taking advantage of the system. That’s a testament to the power of Chapter 7 bankruptcy.

How the bankruptcy means test works

While the specifics of the means test vary from state-to-state, the workings are the same.
Generally speaking, if you earn less than the median annual income in your state, you should qualify for Chapter 7 bankruptcy.
The median income is the center-line of all annual incomes in the state. It is unique to each state, and includes different income levels based on the size of your family. For example, for means test purposes, the median income for a family of four is typically higher than that for a family of two.
Also, the median income for the means test changes every year in every state.
This may sound like a high bar, but more people may qualify than you think. In most states, the median income for 2009 was between $40,000 and 50,000 for a single earner. For a four-person family, the median income was above $70,000 for many states in 2009.
To find out if you qualify for Chapter 7 bankruptcy, and to learn more about how filing for bankruptcy can impact your debt, speak with a local bankruptcy lawyer.

Like physical fitness, financial fitness takes a while to develop – but is completely worth the time and effort you invest. Here are a couple of key behaviors that will help your post-bankruptcy life be as successful as possible.

Budgeting

To make sure you don’t end up in debt again, you need to make sure you spend less money than you make. The best way to avoid overspending is to create a budget – and stick to it.

The first step of budgeting is figuring out where your money goes. To do this, write down every single purchase you make for a month (including bus fare, rent, sodas – everything!). At the end of the month, find the total. If that number is more than your monthly salary, you need to make some adjustments.

Divide your expenses into categories (entertainment, food, rent, etc.) and determine where you could cut back. Sometimes it’s as easy as switching to generic food brands at the grocery store or brewing coffee at home rather than buying it each morning. You may have to be creative and you may have to sacrifice, but you can do it. And you need to.

Once you’ve set yourself a budget, follow it. Remember, this isn’t a punishment, it’s a way to make sure you save money wherever you can so you have cash left over for the things that really matter to you!

Saving

Maybe you were pushed to file bankruptcy because of a financial crisis like a divorce or serious injury. Often, people are flattened by unexpected life events because they don’t have any money saved for emergencies. Creating a safety net is important for your peace of mind and for the surprise needs that will undoubtedly crop up in your life.

Some people are intimidated by saving because they don’t know how to do it or think they don’t have enough money to make saving worthwhile. But that’s a huge mistake. Remember, you’re in this for the long haul. Even if you can only save $20 a month, that adds up over the years. And when you include the compound interest from a savings account, it’s even more.

If you were starting an exercise regimen, you wouldn’t expect it to show results overnight, and saving is the same way. Be patient and be consistent, and you’ll see the benefits.

Rebuild Your Credit

Some people balk at the idea of opening lines of credit after bankruptcy, because credit cards were how they got into debt in the first place. But to establish a strong credit history these days, you need to use credit responsibly.

Right after filing bankruptcy, your credit won’t be very good. The bankruptcy itself will stay on your credit report for 10 years, but its impact on your overall credit rating will decrease with time and positive credit use on your part. But if you don’t use any credit at all, your credit history will contain nothing but the bankruptcy, so even if you’ve been living well and responsibly on cash, lenders will have no proof and won’t be able to offer you attractive rates.

One of the best and surest ways to build healthy credit is to borrow money and pay it back on time. You can do this by opening a credit card (when you’re ready), using it regularly and paying the balance in full each month. You may also be able to take out a loan with help from a cosigner.

The point is to use credit to your advantage and not let credit control you.

Avoid Crisis Behavior

Maybe you maxed out your credit cards or visited payday lenders to make ends meet before your bankruptcy filing. To make sure your finances don’t get out of control again, you must avoid crisis behavior after your filing.

Use What You’ve Learned!

Bankruptcy isn’t an easy process, but it’s necessary for many Americans. Take advantage of the debtor education requirement – put the tips you learn to use to make your finances as strong and healthy as possible. And remember that you’re not alone. Millions of Americans have filed bankruptcy and will file bankruptcy.

Financial freedom is within your reach!