A Rule of Thumb about Choosing between Chapter 7 and Chapter 13

If you qualify for both, first find out whether and how much you’d be helped by Chapter 13, then decide whether Chapter 7 is enough.

 

The Choice is Unique for Each Person

The main point of my last blog post was that Chapter 7 and 13 each have their advantages and disadvantages. Some of those may not be obvious. So it’s important to be open-minded when you meet with your attorney to find out about your options.

Let’s assume you qualify for both Chapter 7 and Chapter 13. Then the choice really depends on your personal, unique combination of circumstances, and on your personal goals.

The “Rule”

However, the following broad rule of thumb may help you start thinking about the choice constructively:

File a Chapter 7 “straight bankruptcy” unless the many extra tools provided by Chapter 13 “adjustment of debts” makes that worthwhile for you instead.

Solve Your Problems

This does not mean that you file under the usually simpler Chapter 7 whenever you qualify to do so. Your goal is not necessarily the simplest bankruptcy. Your goal is a better financial life, and using the right legal tool to get there.

Two Big Truths

The rule of thumb above rises out of two big truths about Chapter 7 and Chapter 13:

1. Although Chapter 7 is usually much simpler than Chapter 13—faster and cheaper,

2. Chapter 13 comes with many potentially very helpful features that are not available under Chapter 7.

Two examples will show how this works.

A Chapter 7 Hypothetical

Imagine that a husband and wife own a home they want to keep. They have fallen behind on the mortgage by three $1,400 payments, totaling $4,200, because one of them was unemployed for several months.

Now that they are both working again they believe that if they filed a Chapter 7 case to discharge all their other debts, they could put all their effort into paying off that $4,200 mortgage arrearage by paying $420 extra each month for the 10 months or so until they were caught up. Their attorney informs them that their particular mortgage lender has accepted similar terms with other homeowners, and the couple is willing to accept the risks involved. Their budget would be tight during those 10 months but livable, so they are confident that they could realistically do it.

So Chapter 7 seems like a sensible option here.

A Chapter 13 Hypothetical

Now take the same situation with two twists. First, instead of 3 months behind the couple is 6 months behind–$8,400—on their first mortgage. Second, they have a second mortgage on which they owe $30,000. Also, the home is worth no more than the balance on the first mortgage.

Assuming that, as in the above Chapter 7 example, they could only afford about $420 per month towards the mortgage arrearage catch-up payments, it’s much less likely that their lender would allow them the 20 months or so to bring the mortgage current after filing a Chapter 7 case.

However, if they filed a Chapter 13 case instead, they could stretch out these catch-up payments over a period of three to five years, reducing the amount to be paid each month to a much lower and sustainable amount. Plus throughout this time they would be under the protection of the bankruptcy court preventing a foreclosure or any other collection activity as long as the couple did as their Chapter 13 payment plan required. And if their circumstances changed, their payment plan could likely be amended to adjust to those changes.

Furthermore, under Chapter 13 (but not Chapter 7), the couple would likely be able to “strip” the second lien off the home’s title, meaning that they would likely avoid paying all or most of that $30,000 balance (together with many thousands of dollars of future interest). This would get them that much closer to building equity in their home.

In this second situation, Chapter 13 makes a lot more sense, being less risky and likely saving them much more money.

Summary

In this second example, Chapter 13 provided some tools—stretching out the arrearage payments and “stripping” the second mortgage–that would enable this couple to save their home while saving a lot of money. In the first example, those tools either were not needed or didn’t apply, so Chapter 7 was the better solution.

 

The Most Important Choice in Bankruptcy

Chapter 13 takes years instead of months, and costs more, so you do a Chapter 7 when you can and a Chapter 13 when you must, right?

 

No, not really.

These two options each have advantages and disadvantages that need to be carefully matched to your immediate problems and to your short- and long-term goals.

The length of a Chapter 13 case can itself be an advantage when you’re trying to buy time or stretch payments out over a longer period to reduce what you pay each month. The likely greater cost of Chapter 13 is sometimes far outweighed by how much you can save through that procedure—possibly even by tens of thousands of dollars. But in other situations Chapter 7 may be just what you need.

Be Informed and Open-Minded

Inform yourself about your options before seeing an attorney (such as by looking through our website). But it’s also wise to have an open mind about those options when you meet with an attorney for legal advice. You may simply not know about a crucial advantage or disadvantage that could swing your decision one way or the other, sometimes contrary to your expectations. So don’t be too emotionally invested in going in one direction when the other may actually be the better choice.

The Easy Choice, and the Sometimes Not So Easy Choice

Sometimes the nature of your debt problems and your other circumstances push your decision strongly towards either Chapter 7 or 13. Sometimes you may even only qualify for one, and that one provides what you need. Or you may qualify for both, but still everything points towards either Chapter 7 or 13. So the decision could be very easy.

But you may well qualify for either a Chapter 7 or Chapter 13 case, with advantages under each one.  So it can come down to a very personal choice.

For Example…

Two simple examples will make this clearer.

First, let’s say you are behind on your home mortgage and wanted to keep the home. A Chapter 7 case would likely write off all or most of your other debts, and do so in just 3 or 4 months. You’d likely have a few months, maybe up to a year or so, to catch up on the mortgage.

In contrast, a Chapter 13 case would give you 3 to 5 years to catch up. And it may allow you to avoid paying most or all of a second mortgage by “stripping” it off your title, saving tens of thousands of dollars. But you wouldn’t be writing off any of your debts until the end of that 3-to-5-year period.

This choice between these two options turns partly on factual issue like whether you have a second mortgage that could be “stripped” and how much you’re behind on the mortgage payments. But on a personal level it comes down on how important it is to you to keep the house. And how much you’d be willing to risk in being able to do that though Chapter 7 by negotiating a relatively quick catch-up of past-due mortgage payments instead of getting much more time and far greater protection through Chapter 13.

A second example: let’s say you owed some past-due income taxes to the IRS that could not be written off under either Chapter 7 or 13. You could file a Chapter 7 case and write off all or most of your other debts for that you could focus your financial resources on the IRS. Right after your bankruptcy case was over you’d arrange with the IRS to make monthly payments to pay off that tax debt, plus ongoing interest and penalties, through monthly payments.

Or you could file a Chapter 13 case and pay those taxes through a formal plan incorporating all of your creditors (with possibly little or even nothing going to some creditors) through a monthly payment based on your budget, usually avoiding additional interest and penalties on the taxes, all the while being protected from the IRS. But you would pay more for these advantages.

This choice also depends on the facts, such as how much tax you owe and how much you could afford to pay each month once your Chapter 7 case was completed. But then it comes down to more personal questions like how confident you’d be that your present income and expenses would stay stable throughout the repayment period so that you could reliably make those payments without the additional protection of an ongoing Chapter 13 case.

Next…

Regardless whether the choice between Chapter 7 and Chapter 13 ends up being easy or difficult, you need to be well-informed about their differences. So the next few blog posts will look at some of the key differences between them.

 

Thanksgiving for the Rule of Law

This Thanksgiving, even in the midst of scary personal financial pressures, there is much to be thankful for.


Everybody can make their own individual inventory of people and situations to be appreciative of Here is a short list of what to be thankful for in the world of bankruptcy:

1. The Rule of Law:

We’re thankful that we live in a country that, for all of its continuous challenges, is a civil society. Without getting into the politics of it all, we can generally rely on our local, state, and national governments to fulfill their basic functions. We don’t live in anarchy. People, from the lowest to the highest, generally try to operate their daily lives following the rules that we have all agreed to live by, our laws.

There are serious challenges to all our institutions—from the U. S. Congress to the U. S. Postal Service. But most of us can generally go about our daily lives without being concerned about being physically harmed by either the police or by other people. Our U. S. Constitution continues, after 226 years, to protect our basic rights. And that includes a system of federal bankruptcy law.

2. The Weak Standing up to the Strong:

We’re thankful that within the laws in general, and in bankruptcy law in particular, the rule of law means that people who are weaker have at least a certain amount of strength and protection.

In the case of bankruptcy, the strength is found in a set of powers with which debtors can push back and get relief from creditors and their debts. For example, the “automatic stay” goes into effect instantaneously when you file any kind of bankruptcy case stopping virtually all collection efforts of creditors. The “discharge” legally writes off most debts forever. These powers undo rights that creditors would normally to enforce contracts and collect debts. Bankruptcy gives you laws that defeat laws that usually help creditors.

That’s pretty extraordinary.

3. Compassion Built into the Law:

We’re thankful that a trait that isn’t often found in the law—compassion—is incorporated into the bankruptcy law.

The evolution of bankruptcy, over the centuries of English and American law, has been towards compassion for the “honest but unfortunate debtor.” An institution that was originally designed as a way for creditors to collect debts has evolved into one mostly used to give relief to debtors.

“Property exemptions” enable debtors in most cases to keep what they have and need. “Reaffirmation” and “redemption” gives options for keeping collateral when doing so is in the debtor’s best interest. The ability of creditors to challenge the “discharge” of debts is usually limited to those situations where there is a good reason that the debt should not be discharged.  

4. No Corruption:

We’re thankful that beyond paying the relatively reasonable filing fees, nobody needs to bribe a court clerk or a judge to get something done. The system is honest and overall fair.

5. Balancing between Debtors and Creditors:

We’re thankful that the bankruptcy laws make a reasonable attempt at balancing the rights and interests of debtors and creditors.

And the system as administered and enforced—all the way from the local bankruptcy court clerk to the U. S. Supreme Court—is done with an earnest attempt to be fair, sensible, and balanced.

6. You Have Choices:

We’re thankful that the result of all of the above is that most people in financial distress have legal options that will bring relief.

Under Chapter 7 “straight bankruptcy” you can usually get immediate relief from creditor pressures. You have the option of surrendering collateral like a vehicle or home and owing nothing, or keeping the collateral and paying for it, sometimes not the full amount. You usually protect everything else you own through “exemptions.” And then almost always after only 3 or 4 months all or most of your debts are permanently discharged.

Under Chapter 13 “adjustment of debts” beyond the immediate relief from creditor collection efforts, this protection lasts the whole 3-to-5-year period that you are in a payment plan. That plan is put together by you and your attorney following a set of rules; creditors have only a limited say about the terms of that plan. The Chapter 13 plan gives you the opportunity to  pay important debts that you either can’t discharge in a Chapter 7 case—such as child support—or which you don’t want to discharge—such as a vehicle loan or home mortgage. You may also qualify for various significant benefits—such as stripping a second mortgage off your home, or doing a “cramdown” of your vehicle loan or other collateralized debt.

In both of these options you generally finish with the elimination of or a huge reduction in debt and a fresh financial start.

We hope the prospect of that helps you have a good Thanksgiving this year, and perhaps a better one next year.

 

Chapter 7 and Chapter 13–Unsecured Debts

Which of the two consumer bankruptcy options is better for you if you have lots of unsecured debts depends on the kind of unsecured debts.  

 

Unsecured Debts

Debts that are unsecured are those which are not secured by anything you own. The creditor has no “security interest” in anything, no right to repossess anything if you don’t pay the debt.

In general it’s easier to deal with unsecured debt than secured ones in bankruptcy.

Unsecured Debts Turning into Secured Ones

Unsecured debts can turn into secured ones if you don’t pay them. A credit card holder or medical provider can sue you for the balance owed, get a judgment against you, and usually can record that judgment as a lien against your home and other possessions. If you don’t pay your federal income taxes the IRS can record a tax lien against your real estate and personal property without suing you.

Under some circumstances bankruptcy can turn an unsecured debt that had been turned into a secured one by the creditor back into an unsecured one. But not always. For example, an older income tax debt that could have been completely “discharged”—written off without paying anything—may have to be paid in full once a tax lien was recorded on it. So in general it’s better to file a bankruptcy case before creditors can turn unsecured debts into secured ones.

Secured Debts Turning into Unsecured Ones

When a secured creditor repossesses or forecloses on something you own, and sells it and credits the sale proceeds against your balance, if there’s still a remaining debt it is now unsecured.

“Priority” and “General Unsecured” Debts

There are two broad kinds of unsecured debts.

“Priority” debts are those that the law treats as special because of different “policy” reasons for treating that particular kind of debt more favorably. For example, unpaid child support and income taxes are “priority” debts. Congress has determined that bankruptcy should not be able to discharge child support or hinder its collection because of the high value Congress places on the payment of child support. And income taxes are considered a social obligation that we should not be able to avoid easily. And yet income taxes can be discharged if they are old enough and meet some other conditions.

“General unsecured” debts are simply unsecured debts that do not fit into any of the “priority” debt categories. “General unsecured” debts include most unsecured ones, such as medical and credit card debts, retail accounts, personal loans, many payday and internet loans, unpaid utilities and other bills, claims against you arising out of vehicle accidents other injuries, and out of contractual and business disputes, overdrawn checking accounts, bounced checks, the remaining debt after a vehicle repossession or real estate foreclosure, many kinds of debts from operating a business, and on and on.

Chapter 7 vs. Chapter 13

Speaking very broadly, if all your unsecured debts are “general unsecured” and are not “priority” ones, you’d lean towards filing a Chapter 7 “straight bankruptcy” case.

That’s because it usually discharges (writes off) those debts quickly, in a matter of 3 or 4 months, and almost always without you needing to pay anything on those debts.

In contrast, in a Chapter 13 “adjustment of debts” case you would usually have to pay some portion of your “general unsecured” debts (although in some situations you may not pay anything). Also, the discharge of the remaining unpaid portion would not happen until the end of the 3-to-5-year payment plan. And maybe most important, if you do not successfully complete the Chapter 13 case—which have a much lower percent completion rate than Chapter 7 cases—that remaining portion of the “general unsecured” debts would not be discharged at all and you’d continue owing them.

On the other hand, again speaking very broadly, if you have a “priority” debt or more than one of them, and especially if that debt or those debts are large, you may lean towards filing a Chapter 13 case. That’s because it has better tools for dealing with “priority” debts than Chapter 7.

In the next few blog posts we’ll look at the various kinds of “priority” debts to see how each is handled under Chapter 7 and Chapter 13. In particular we’ll look at circumstances in which each kind of “priority” debt can be appropriately handled in a Chapter 7 case vs. when that kind of “priority” debt needs the extra help of Chapter 13.

 

Chapter 7 and Chapter 13–Home Mortgage Overview

How do these two consumer options help with your home mortgage(s)?


Chapter 7 “Straight Bankruptcy”

A Chapter 7 case usually lasts about 3-4 months. It doesn’t reduce your monthly mortgage payment, and doesn’t directly help you deal with your mortgage lender if you’re behind.

Instead through Chapter 7 most or all of your other debts are gotten rid of so that you are better able to catch up if you’re behind, and can better afford your mortgage and other home-related debts and expenses overall.

Chapter 13 “Adjustment of Debts”

A Chapter 13 case usually takes 3 to 5 years. That’s because it involves putting together and then executing on a court-approved monthly payment plan through which you usually pay a portion of your debts, and often only a small portion.

Although your first mortgage payment can’t be reduced, in some circumstances you would not need to pay a second (or third) mortgage payment. If behind on the mortgage you’d have the 3 to 5-year length of the payment plan to catch up.

You can better afford your mortgage and other home-related debts and expenses for two reasons: because your other debts are usually radically reduced, and because you are protected for an extended time from special creditors while you pay them. Those special creditors include home-related ones like your property tax agency, and also ones not directly related to your home like your child/spousal support arrearage and income taxes.

How Much Protection You Need

Both Chapter 7 and 13 stop a scheduled foreclosure sale through the power of the “automatic stay,” which prevents most creditor actions from acting against you and your home from the moment your bankruptcy case is filed.

The difference is how long that protection lasts.

SHORT Protection from Foreclosure and Other Action by Your Mortgage Lender

Sometimes you only need that protection for a short time. You may have struggled to stay current on your home mortgage(s) and just need relief from your other debts so that you can keep current. You may have decided to move away from the house and just need a few more months to save moving costs and first/last month’s rent. You may want to stay, are behind on the mortgage, but just need to work out a “forbearance agreement” with your mortgage lender to catch up during the next year or so.

For these situations the relatively short length of protection provided by Chapter 7 would likely be appropriate.

LONG Protection from Foreclosure and Other Action by Your Mortgage Lender

But you would need longer and more powerful protection in the following situations:

  • You are further behind on your mortgage than you can catch up within a time period that your mortgage lender would allow in a voluntary “forbearance agreement.”
  • You are also behind on property taxes and need a way to catch up on both the mortgage and the taxes while being protected from foreclosure by both.
  • You can’t afford to catch up or simply to pay your mortgage because of special debts that would not be written off (“discharged”) in a Chapter 7 case, and so you need to pay those special debts over an extended time while being protected from liens and other harm those special creditors could inflict. Examples are such special debts are recent income taxes, child/spousal support arrearage, and student loans.
  • You believe you want to keep your home for a few years, and then maybe sell it at the right time for you. You need the flexibility of a payment plan and protection from your creditors that allows you to put off selling your home for now, and provides some flexibility as your work/family/personal plans change.

For these situations the relatively long protection provided by Chapter 13 would likely be more appropriate.

 

I Need a Bankruptcy But Already Filed One a Few Years Ago

If you need bankruptcy protection but already filed a case within the last few years, you may still be able to file a new one now.

 

You’ve likely heard that you have to wait a certain amount of time to file a bankruptcy case after having filed a previous one. But there are all kinds of unexpected opportunities here when we look more closely.

Previous Bankruptcy FILING vs. DISCHARGE

This can be a critical distinction: the rules about when you can file a new case turn not merely on whether a previous case was FILED but rather whether one was filed in which you received a DISCHARGE of your debts. The laws in the Bankruptcy Code about when you can file a new case refer to whether in the prior case “the debtor has been granted a discharge” or “has received a discharge.”

In other words, if your previous case was not successfully completed—if it was dismissed before you finished it—you would not be prevented from filing a case now. If your prior case did not result in a discharge of debts, you do not have to wait ANY period of time to file a new case. 

Did You Definitely Get a Discharge of Debts?

So, if you’ve filed a previous bankruptcy case and are now having to consider filing a new one, make sure to find out whether you got a discharge in that previous case.

If you distinctly remember that your case finished the way it was supposed to, you very likely DID get a discharge. Then the timing rules we’re about to tell you about do apply. Otherwise, if there was no discharge in the previous case than you don’t have to wait, the timing rules don’t apply.

So definitely make sure to find out. Find out from the attorney who represented you in the previous case. Or look through your old paperwork to find the discharge order issued by the Bankruptcy Court, or instead an order dismissing your case without a discharge. Your new attorney can also likely find out for you what became of your previous case.   

The Timing Rules

Assuming that you did receive a discharge of your debts in your previous case, here are the timing rules.

You may have heard that you have to wait 8 years between bankruptcy filings. But that length of time only applies to one out of a number of possible scenarios: the length of time from the filing of the previous discharged Chapter 7 “straight bankruptcy” case to the filing of a new Chapter 7 case. (See Section 727(a)(8) of the Bankruptcy Code.)

However, if your previous case was a Chapter 7 one and you now want to file a Chapter 13 “adjustment of debts” case, the length of time is only 4 years. (Section 1328(f)(1).)

Or if your previous case was a Chapter 13 one and you now want to file a Chapter 7 case, the length of time is only 6 years. And in fact if that previous Chapter 13 case was one in which through your payment plan you paid your unsecured creditors 70% or more of what you owed, then you don’t have to wait at all to file a Chapter 7 case afterwards.  (See Section 727(a)(9).)

And if your previous case was a Chapter 13 one and you now want to file a Chapter 13 case, the applicable length of time is only 2 years. (See Section 1328(f)(2).)

The Clock Starts Running at the Previous Case Filing NOT the Discharge

The event that triggers the start of all these time periods is the filing of the previous case, not the subsequent discharge in that case. The discharge comes at or near the end of a case. The filing is at the very beginning of the prior case.

Take the example of the above 6-year rule for filing a Chapter 7 case after a previous Chapter 13 one. If that previous Chapter 13 case was filed on October 1, 2009, and it took 3 years to complete so that the discharge was entered in October 2012, you would be able to file a Chapter 7 case starting October 1, 2015, 6 years from the filing date (regardless when the discharge was entered).

 

How Can You Protect Your Co-Signer in a Bankruptcy Case?

If you jointly owe a debt with someone, bankruptcy protects not only you but also your co-signer.

 

The last blog post was about how to protect yourself from a co-signed creditor and also from your co-signer. This one is about protecting the co-signer.

If your priority is to prevent your co-signer from being financially harmed, you have two options.

The Chapter 7 Option

You can commit to making your co-signer whole by paying him or her back whatever amount the creditor makes him or her pay on the co-signed debt. That could be impossible if you are under serious financial pressure from your other creditors. So to make it possible to pay back your co-signer, consider filing a Chapter 7 “straight bankruptcy” to discharge all or most of your other debts.

To be clear, the law clearly allows you to pay a debt that you have “discharged” (written off in bankruptcy) if you want, by paying the co-signed creditor or the co-signer if he or she has already paid off the debt at that point.  

When filing that bankruptcy case you would make sure to list both the creditor AND your co-signer—for two reasons:

  • You are required under bankruptcy law to list all legal obligations. You clearly have a legal obligation to the creditor itself. And you likely have a legal obligation to your co-signer to pay him or her when he or she is forced to pay the co-signed creditor.
  • You must list both debts in your bankruptcy case if you want to legally discharge them both. Even if you intend to pay your co-signer, doing so when you have no legal obligation to do so is much more favorable to you. You can dictate the terms of repayment. And if your circumstances change, or if your relationship with your co-signer deteriorates, you can reduce the payment amounts or stop paying your co-signer altogether.  

The Chapter 13 Option

You can often protect your co-signer much better under Chapter 13 “adjustment of debts.” If you file a Chapter 7 case, that does not stop the co-signed creditor from pursuing and suing your co-signer. In fact your very act of filing a Chapter 7 case could even trigger the creditor’s pursuit of your co-signer, because your filing cuts off the creditor’s ability to pursue you.

Filing a Chapter 13 case prevents this problem. Through the “co-debtor stay,” creditors may not pursue your co-signer except under certain circumstances. So you could either prevent your co-signer from being sued in the first place, or right after being sued you could prevent that lawsuit from going any further against the co-signer.

This “co-debtor stay” of Chapter 13 extends to “any individual that is liable on [a consumer] debt with the debtor.”  

But this protection for your co-signer has significant limitations:

  • It only applies to consumer debts—co-signers on business debts, such as SBA loans, are not protected.
  • Taxes are not considered consumer debts for this purpose, so this does not work to protect people—ex-spouses or ex-business partners, for example—from the IRS or other taxing authorities.
  • The protection only lasts as long as your Chapter 13 case is active—whether your case is dismissed because of some problem or is completed in the usual three to five-years, after that to the extent the debt is still owed the creditor could then pursue your co-signer.
  • Even while your Chapter 13 case is active, the creditor could ask the court for permission to pursue your co-signer on either of two grounds:
    • if your co-signer received the benefit from the use of credit (such as the money lent), and not you
    • if the Chapter 13 plan does not pay the debt to the creditor in full

So Chapter 13 enables you to completely and permanently protect your co-signer on a consumer debt only if your Chapter 13 plan is designed to pay that creditor’s debt in full, and you in fact complete that plan accomplishing that pay-off. In most jurisdictions you are allowed to favor the co-signed debt over most of your other debts. That often makes Chapter 13 your best alternative if protecting your co-signer is very important to you.  

 

Chapter 7 and Chapter 13–Exempt and Not Exempt Assets

Most of the time everything you own is exempt, meaning it’s protected in a Chapter 7 bankruptcy. If not, Chapter 13 can usually protect it.

 

Our last blog post was about keeping or surrendering assets which are security on a secured debt—such as a vehicle on a vehicle loan, a home with a home mortgage, or a household appliance on a secured store credit card or contract.

Today we discuss protecting assets that are not encumbered by any debt. So these assets cannot be repossessed by any secured creditor. However, your creditors would have a right to even these unencumbered assets if an asset is not “exempt.”

Here’s what property exemptions are and how they protect you under a Chapter 7 “straight bankruptcy” and under a Chapter 13 “adjustment of debts.”

The Simple Principle

Choosing between Chapter 7 and 13 on the specific issue of protecting your possessions is based on a very straightforward principle. If everything you own and want to keep fits within the property exemptions that are available to you, you can file a Chapter 7 case and keep everything; otherwise you need the extra help of a Chapter 13 case.

Property Exemptions

Exemptions are a list of categories of assets, with each category usually assigned a maximum dollar amount, that you are allowed to keep protected from your creditors.

For example, if a vehicle exemption in the amount of $3,500 was available to you, and you owned a vehicle worth no more than that, a creditor that did not have a lien on your vehicle could not take that vehicle to pay the debt you owe it.  

This hypothetical $3,500 amount protects not just to the entire value of a free and clear vehicle, but also that much in equity on a vehicle with a loan on it. For example if the vehicle was worth $12,000 but had a $9,000 loan on it, the $3,000 in equity in this vehicle would be protected. Again we are talking about this vehicle being protected from creditors other than the one with a loan and lien on it–see our last blog post about protecting this vehicle from its secured creditor.  

The sensible idea behind property exemptions is that you should be able to retain at least a certain amount of possessions from your creditors so that you do not become destitute and a burden on society. The practical assumption is that financial rehabilitation is inhumanely difficult if you have nothing—no roof over your head, no car to get to work in, no furniture—upon which to rebuild your life.

State and Federal Exemptions

Before looking at how exemptions work in Chapter 7 and Chapter 13, let’s clear up something that is often a source of confusion. Each state has its own set of property exemptions used for bankruptcy and non-bankruptcy purposes. The federal bankruptcy law also contains its own set of exemptions. Which one do you use?

Depends what your state allows. Because of a compromise in the bankruptcy law resolving a conflict between states’ rights and federal power, each state is allowed to either require its bankruptcy-filing residents to use that state’s set of exemptions or to have a choice between those state exemptions and the federal ones.

So, in all states its residents can use their state’s exemptions, and in 19 states (plus the District of Columbia) residents also have the option of using the federal exemptions. These 19 states are Alaska, Arkansas, Connecticut, Hawaii, Kentucky, Massachusetts, Michigan, Minnesota, New Hampshire, New Jersey, New Mexico, New York, Oregon, Pennsylvania, Rhode Island, Texas, Vermont, Washington, and Wisconsin.

Applying the Simple Principle

The simple principle we started with should make a little more sense now. If you live in any of the 31 states where you must use that state’s set of exemptions, you need to see if those exemptions cover everything you own and want to keep. And if you live in any of the specified 19 states plus Washington D. C., see if either your state’s exemptions or the federal ones in the Bankruptcy Code cover everything you own and want to keep.

Under Chapter 7

If the answer in either set of states is yes—if everything you own is exempt—you can file a Chapter 7 “liquidation” bankruptcy and nothing of yours would be liquidated. You would have a “no-asset” case, meaning that the trustee—an agent for all your creditors—would collect no assets from you to distribute to your creditors.

If you do own something that is not exempt but you want to keep, and you still want to file a Chapter 7 case, there is a possible option: the trustee may be willing to let you keep it by paying for the right to do so.

Take the example of the $3,500 vehicle exemption above. If you owned a vehicle worth $8,000 only $3,500 of it would be exempt, leaving the remaining amount of $4,500 unprotected. A trustee would likely accept payment of $4,500 from you and allow you to keep the vehicle, saving him or her the trouble of selling it.

The trustee would even likely accept somewhat less than $4,500 from you because he or she would have incurred some costs in selling your vehicle, which would have reduced the $2,500 in sale proceeds. So if the trustee would have had to pay $500 in fees to an auto auction to sell off the vehicle, you may only need to pay the net amount of $4,000 to keep the vehicle. The trustees may even accept monthly payments on that amount over the course of 10 or 12 months or so instead of a lump sum payment.

Either way, after receiving the $4,000 from you the trustee would divvy that up among your creditors, doing so according to a prioritization scheme laid out in the law.

Under Chapter 13

How does Chapter 13 protect a non-exempt asset that Chapter 7 can’t?  Somewhat similarly as in the example immediately above, but in a way that would often give you much more control over the situation.

In a Chapter 13 case you have 3 to 5 years to pay the creditors at least as much as they would have received in a Chapter 7 case. So, using the above example in which you would have paid the trustee $4,000, under Chapter 13 your monthly payment plan would have to earmark at least $4,000 to the creditors over its 3 to 5 year span (as well as wall as perhaps more to satisfy some other special debts that are better paid under Chapter 13).

Not only would you likely have much longer to take care of that obligation under Chapter 13, you’d have more flexibility. Your payment plan could pay other more urgent creditors ahead of this $4,000, such as a home mortgage arrearage or back payments on child support.

And if you owe a special debt, like say $4,000 for income taxes owed to the IRS on a recent tax year, your Chapter 13 payments could all go to the taxes that you would have to pay anyway instead of to your other general creditors.

The same thing would happen in a Chapter 7 case—the IRS would be paid ahead of and here instead of any other creditors from the $4,000 you would have paid. But under Chapter 13 you would not only have so much more time to take care of that tax debt, thereby reducing your monthly payment, and more flexibility in paying other important creditors, you would also be protected from the IRS’s collection actions throughout 3-to-5-year payment plan.

 

Chapter 7 and Chapter 13

Sometimes it’s obvious which of the two consumer bankruptcy solutions is right for you. But not always. You might be surprised.

 

7 vs. 13

The two main kinds of consumer bankruptcy are extremely different.

Chapter 7 “straight bankruptcy” usually lasts no more than 3 or 4 months. Chapter 13 “adjustment of debts” is seldom completed in less than 3 years and can last as long as 5 years.

Chapter 7 focuses on the discharge of debts while Chapter 13 on the payment of (special) debts.

Both have trustees involved but in Chapter 7 he or she is a liquidating agent (although usually with nothing to liquidate), while in Chapter 13 he or she is mostly a payment disbursing agent.

Most Chapter 7s don’t have court hearings, nor do they directly involve the assigned bankruptcy judge except behind the scenes and for very specific functions. Chapter 13s generally have at least one court hearing for approval of the payment plan, and sometimes have multiple hearings over the course of a case, although most of the time you don’t need to attend them.

And maybe most importantly, Chapter 7s focus mostly on one moment in time—when your case is filed—while Chapter 13s look at the entire span of years that the payment plan is in effect.

As a result, under Chapter 7 debts are discharged or not, assets are protected or not, and collateral is kept or surrendered. Chapter 13 is much more fluid—debts that can’t be discharged can be handled in many creative and powerful ways, assets that otherwise would be lost can usually be protected, and collateral that would otherwise be taken by the creditor can often be saved or sometimes sold years later.

Obvious or Not?

With such stark differences between these two ways of handling debts, you’d think that picking between them would be easy. Indeed much of the time it is.

You may not lose any assets because they’re all protected through exemptions, most or all of the debts will be discharged, the collateral on secured debts are either “reaffirmed” or surrendered, and the disposable income is not too high for the “means test,”, so everything for you points in favor of Chapter 7.

Or else the opposite is true for you. Some crucial asset is not exempt so it needs further protection, significant debts would not be discharged and need to be paid over time while you are protected from the creditors, a vehicle loan needs to be “crammed down” or a second mortgage needs to be “stripped” from the your home’s title or an income tax lien needs to be valued so that you can pay the tax a minimal amount and have the tax lien released, and/or the disposable income is too high to pass the “means test,” so everything for you points in favor of Chapter 13.

But the stars certainly do not always all align on one side or the other. It can often be a mixed bag.

What if most everything point towards a Chapter 7 case, but you could save hundreds of dollars a month and many tens of thousands of dollars over time with a second mortgage “strip,” which can only be done under Chapter 13? There are numerous possibilities like this.

So even if you went to meet with an attorney thinking you’d file a Chapter 7 simple bankruptcy, it would be wise to keep an open mind in case you learned that you would not qualify for Chapter 7 or that it came with disadvantages, and/or that Chapter 13 gave you big advantages you hadn’t known about.

The Project

So to help you understand what these two procedures can do for you, our next several blog posts will look at different financial problems and how they could be solved (or not solved) under Chapter 7 and under Chapter 13.

We’ll start first with problems about things you own—assets; how Chapter 7 and 13 enable you to keep what you want, and let go of what you don’t want or can’t have.

Then we’ll get into the heart of the matter—debts. How these two procedures handle various kinds of debts, common debts and special ones like various kinds of taxes, child and spousal support, debts voluntarily secured by collateral, and those involuntarily secured through judgment and tax liens and such.  

We’ll finish with problems involving your income and expenses, including how to qualify for each of these procedures, as well as other aspects important for rounding out this comparison between the two.

Please join us on this ride for the next few weeks.

 

Making Sense of Bankruptcy: Does Chapter 7 or Chapter 13 Better Protect Your Home?

Although either kind of bankruptcy will stop an approaching foreclosure, which one should you choose?

 

Today’s blog post is summarized by this sentence:

Generally, file a Chapter 7 “straight bankruptcy” if it buys you enough time, and otherwise file a Chapter 13 “adjustment of debts” if you need your more time, but like so much in life it really depends on all your circumstances, with some examples of when Chapter 7 would be appropriate and a list of special advantages that Chapter 13 can get you.

The Simplistic Guideline

If you are behind on your mortgage payments, and definitely want to keep your home, then the simple rule is to file a Chapter 7 case if it enables you to catch up on your back mortgage payments and any other house-related debts (like property taxes) as fast as you need to; otherwise file a Chapter 13 case to give you much more time.

If you are behind but want to either sell or surrender you home, file a Chapter 7 case if you only need to buy a few weeks or a few months and file a Chapter 13 case if you need more time, potentially even a year or two.  

But It Depends

Many considerations can come into play in deciding between a Chapter 7 or 13, including ones that have nothing to do with your home (such as other special debts like income taxes or your vehicle loan). For the purposes of this blog post we focus only on considerations related to saving your home.

For example, if you’re behind on your first mortgage, whether you’ll be able to catch up through a Chapter 7 case include considerations such as: how much in missed payments you owe, how much you’d be able to pay extra each month after discharging (writing off) your other debts, how flexible your particular mortgage lender would be in giving time to catch up, whether you’re also behind on your property taxes, whether you qualify for a mortgage modification, and whether you have a second mortgage that could be “stripped” in a Chapter 13 case (see below). So, every homeowner’s situation is different and requires a careful analysis.

When Chapter 7 Could Be Enough

In your own unique situation would Chapter 7 buy you enough time or would you instead need the much stronger medicine of Chapter 13?

Here are some examples where Chapter 7 may be enough to save your home:

  • You are only a few months behind on your mortgage payments, have steady income, have a lot of debts that would be discharged, enabling you to catch up on your mortgage in several months after filing bankruptcy.
  • You have some money coming to pay the back mortgage payments, but have run out of time before the foreclosure sale date, and just need to buy a few weeks or couple months of time.
  • You have a sale pending on your house but again have run out of time with an approaching foreclosure.
  • You are very close to getting a mortgage modification approved with your mortgage lender, or are more likely get it approved after discharging you debts in bankruptcy.
  • You have decided to surrender the house but need a little more time to accumulate the money needed for a rental.

Chapter 13 Advantages

If you are facing a foreclosure, often you need more time than Chapter 7 would give you. And often you need other special benefits that only Chapter 13 can give you.

For example, your income may have gone down in the recent past because of unemployment or a lower paying job, so that keeping up with the home mortgage payments became impossible. If so, you may simply be too far behind even with what Chapter 7 would save you each month (in debt payments) to be able to catch up with the mortgage anywhere close to what your mortgage lender would require. You may well need Chapter 13 because it can give you as much as five years to catch up.

It can also buy you much more time to sell your home, until you are in a better time of year for home sales, have reached a point in your family’s life when moving makes more sense, or even until the home’s value increases a year or two later.

 Beyond buying time with your mortgage lender, Chapter 13 lets you:

1.  Take extra time to pay unpaid property taxes, while protecting the home from tax foreclosure, and preventing your mortgage company from exercising its option to foreclose first.

2.  Sometimes enables you to “strip” your 2nd (or 3rd) mortgage from your home’s title, so that you don’t have to pay that monthly payment ever again, and likely only have to pay a very small portion of that debt, so that you be become closer to building equity in your home.

3.  Prevent federal and state income tax liens, child and spousal support liens, and judgment liens from attaching to your home in the first place, which prevents these tough creditors from gaining a huge advantage over you.

4.  Pay off income tax liens and support liens if they have already attached to your home, while under the protection of the bankruptcy laws, undercutting the leverage those liens have over you.

5.  Stop existing judgment liens from foreclosing on your home

6.  “Avoid” judgment liens so that they no longer attach to your home at all.

7.  Prevent creditors secured by your home from pursuing your co-signers.

8.  Favor most of your home-related creditors that you need and often want to pay—mortgage companies, tax and support lien holders, and construction and utility lien owners—over most of your other creditors.