Filing bankruptcy helps people eliminate most types of debt and achieve a fresh financial start, but not without limitation. The advantages and disadvantages of bankruptcy can depend on the type or “chapter” of bankruptcy filed.
The bankruptcy code is organized by chapters that offer different types of bankruptcy protection for debtors in different situations. For individuals (and married couples), there are two chapters most commonly used—chapter 7 and chapter 13. While there are some common features of all bankruptcies, these two chapters offer very different protections in certain situations. Choosing which chapter is right for you can be the most important part of the bankruptcy process.
Benefits and limitations common to both types of bankruptcy
Filing any type of bankruptcy instantly stops most types of collection activity, including annoying telephone calls, wage garnishments, and most types of lawsuits. This is called the automatic stay.
Unfortunately there are some limitations to the automatic stay and it is important that these are talked about just as much as the benefits of bankruptcy so that anyone considering bankruptcy can know what to expect in advance.
The automatic stay does not stop support obligations such as child support or spousal maintenance. These family support obligations, including arrears, are non-dischargeable in bankruptcy and collection action will continue unaffected.
For secured debts, like an automobile or real estate (with a mortgage), the automatic stay will only suspend repossession or foreclosure temporarily. Secured debts need to be paid if the debtor wants to retain the collateral. This is an area where chapter 7 and chapter 13 are very different as chapter 13 may enable the debtor to catch up on delinquent payments through the bankruptcy plan.
The primary benefit of either chapter of bankruptcy is that, once the process is complete, most types of debt are eliminated, including medical bills, credit cards, and personal loans. But, continuing the theme here, this is not without limitation.
Neither type of bankruptcy will discharge student loan debt (without a separate process to prove a legally-specific hardship). And, as mentioned briefly before, secured debts are treated differently depending on the chapter of bankruptcy. A secured debt is a type of debt where the borrower promises collateral, such as the return of property purchased, in the event of nonpayment. Besides automobile loans and mortgages, another common type of secured debt is a furniture store charge card. These debts are treated differently depending on the type of bankruptcy filed.
Chapter 7 bankruptcy
For most debtors, the primary benefit of chapter 7 bankruptcy is its simplicity. Chapter 7 bankruptcies are relatively quick and inexpensive; and enable qualified debtors to eliminate most debts without repayment. Most chapter 7 bankruptcies can be completed within about ninety days.
But not everyone qualifies for chapter 7. Debtors must pass a means test and must have a certain debt-to-income ratio to file under this chapter. Its limitations do not end there. The process requires debtors to surrender all “non-exempt” personal property to be sold by the bankruptcy trustee. Arizona’s bankruptcy exemptions typically are more generous than other jurisdictions, but the potential to lose personal property is a very real and very important consideration for anyone thinking about filing chapter 7 bankruptcy.
Chapter 13 bankruptcy
Chapter 13 offers an alternative for debtors who do not qualify for chapter 7 or who need flexibility to retain additional property. It involves a three to five year payment plan based on the debtor’s disposable income. When the plan completes, any remaining debts that are dischargeable are eliminated.
Beyond the discharge of most types of debt, chapter 13 uniquely enables debtors with delinquent mortgage payments to stop foreclosure and cure the past due payments over the life of the bankruptcy plan (though debtors must continue to make regularly scheduled monthly mortgage payments).
It also can enable debtors to retain non-exempt personal property that would be surrendered and liquidated in chapter 7 bankruptcy. And for automobiles and other secured property (excluding real property) that may be “underwater,” chapter 13 may enable debtors to “cram down” the outstanding loan balance to match the value of the property.
The fact that debtors have to commit to a repayment schedule is often viewed as its biggest limitation. But for many debtors, the monthly payment is far less than the combined minimum payments due to the creditors and the debts are eliminated at the end of the term.