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Here are some things to think about before you decide to file for Chapter 7 or Chapter 13 bankruptcy.

For many individuals, filing for bankruptcy relief can provide a way out of debt and a fresh financial start. But whether a bankruptcy filing is in your best interest will depend on many factors and your circumstances. Read on to learn more about what to consider if you are thinking about filing for Chapter 7 or Chapter 13 bankruptcy.

Is Bankruptcy the Best Choice?

Bankruptcy will impact your credit score for years to come. So it’s a good idea to evaluate all of your options before deciding to file for bankruptcy. Many creditors are willing to work with debtors to settle their debts. If you can resolve your financial issues outside of bankruptcy, you might not need to file for bankruptcy.

To learn more about your options, see Alternatives to Bankruptcy.

Should You Choose Chapter 7 or Chapter 13 Bankruptcy?

Chapter 7 bankruptcy works well for people who can protect all of their property with exemptions, whose income is low enough to meet qualification requirements, and whose debt is the type that bankruptcy will discharge.

By contrast, Chapter 13 bankruptcy works best for people:

  • whose income is too high to qualify for Chapter 7 bankruptcy
  • who would like to save a house from foreclosure or a car from repossession, or
  • who want to pay back nondischargeable debt, such as back child support or income tax debt, through a three- to five-year repayment plan.

So when considering whether it’s in your best interest to file for Chapter 7 or Chapter 13 bankruptcy, keep in mind that it will depend on numerous factors including:

  • the type of debts you owe
  • your income and expenses
  • whether you’ll lose property, and
  • what you hope to achieve with bankruptcy (such as keeping a house or car).

To learn more about when it makes sense to file for Chapter 7 or Chapter 13 bankruptcy, see When Chapter 7 Bankruptcy Is Better Than Chapter 13 Bankruptcy and When Chapter 13 Bankruptcy Is Better Than Chapter 7 Bankruptcy.

Will Bankruptcy Wipe Out Your Debt?

Before you file your case, you’ll want to think about the goals because a bankruptcy discharge doesn’t eliminate certain types of debt (called priority obligations). For instance, you can wipe out most credit card obligations, medical bills, and personal loans. But you can’t discharge domestic support obligations (such as child and spousal support), newer tax debt, student loans (unless you can prove undue hardship), and more.

The bottom line is that filing for bankruptcy might not be in your best interest if you can’t get rid of your debt. However, bankruptcy can help in other ways. For instance, you can pay off nondischargeable debt over three to five years in a Chapter 13 case.

(For detailed information about specific debts in bankruptcy, see Your Debts in Chapter 7 Bankruptcy and Your Debts in Chapter 13 Bankruptcy.)

Is Your Lender About to Foreclose on or Repossess Your Property?

If you have debts secured by your property (such as a mortgage or car loan), your lender can foreclose on the home or repossess the car if you default on your obligation (or take any other property that serves as collateral for the debt). Your lender has this right because of the lien you agreed to when you took out the loan.

In most cases, you can’t wipe out your lender’s lien on the property with a bankruptcy discharge. Even after the bankruptcy, if you don’t make the loan payments, the lender can take back the property.

However, bankruptcy’s automatic stay can stop or delay the foreclosure and repossession process. The relief afforded by the stay in Chapter 7 bankruptcy is usually temporary. But filing for Chapter 13 bankruptcy might allow you to:

  • keep the property and catch up on your missed payments
  • reduce the balance of your loan if you qualify for a cramdown, and
  • eliminate wholly unsecured junior liens from your house through a process called lien stripping.

To learn more about how Chapter 13 bankruptcy can help you save your home or car, see Your Home and Mortgage in Chapter 13 Bankruptcy and Your Car in Chapter 13 Bankruptcy.

Are You Facing a Collection Action, Garnishment, or Lawsuit?

If you don’t make the required payments on your debts, your creditors can take you to court to recover their money. A creditor that obtains a judgment against you in court can use it to garnish your wages or place a lien on your assets. Some creditors, like the IRS or your student loan lender, can take action without stepping into the courtroom. (Learn more about the ways that creditors can collect debts.)

When you file for bankruptcy, an automatic stay goes into effect that stops almost all collection actions, including lawsuits and garnishments. Filing for bankruptcy relief can also eliminate the underlying debt.

For more information on bankruptcy and collection activities, see Bankruptcy’s Automatic Stay.

Can You Protect Your Property?

One of the most important things to consider before filing for bankruptcy is whether you’ll be able to keep all of your property. Bankruptcy exemptions allow you to protect a certain amount of assets in any bankruptcy chapter that you file. What will happen to nonexempt assets will depend on whether you file a Chapter 7 or Chapter 13 bankruptcy.

  • Chapter 7 bankruptcy. A Chapter 7 bankruptcy trustee has the authority to sell any assets you can’t exempt and to use the proceeds to pay back your creditors.
  • Chapter 13 bankruptcy. You can keep all of your property in a Chapter 13 bankruptcy. However, you’ll have to pay your unsecured debts (such as credit card balances, medical bills, and personal loans) at least an amount equal to the value of your nonexempt assets. If you have a significant amount of nonexempt property, filing for bankruptcy might not be in your best interest.

What Is Exempt Equity?

People who file for bankruptcy don’t lose all of their possessions. A bankruptcy filer can protect—or exempt—a certain amount of assets regardless of the bankruptcy chapter filed. The dollar amount of an ownership interest that you can protect is called “exempt equity.”

Calculating exempt equity is a two-step process. First, you’ll find out how much of an item’s value you can protect, or “exempt.” You’ll do so by consulting your state’s exemption statutes.

Although some exemption statutes tell you the number of items that you can protect, such as one motor vehicle or all prescribed health aids, others allow you to keep property valued up to a particular amount. For instance, you might be able to retain $50,000 in a home or $10,000 in household items. The dollar amount tells you how much equity you can exempt.

The next step is figuring out how much equity you have in your property (the funds remaining after selling the property and paying off any outstanding loans).

Suppose, for instance, that you were considering selling your house. To figure out the amount of your equity for bankruptcy purposes, you’d subtract your mortgage from the market value (the price your house would sell for). The remaining amount would be your equity.

By contrast, if you own a bicycle free and clear, you’d be entitled to all sales proceeds. Therefore, your equity would be its market value.

You can own property without equity, too. If you do, you won’t use an exemption because there won’t be anything to protect.

Example. Audrey took out a loan to buy a $20,000 car. When she filed for bankruptcy, she owed $15,000. However, the car’s value dropped to $10,000. Because the lender would receive all of the sales proceeds if the vehicle were sold (the $10,000 value equaled the amount owed to the lender), Audrey didn’t have any equity to protect with an exemption.

For more information on what happens to your property in bankruptcy, see our topic areas on Your Property in Chapter 7 Bankruptcy and Your Property in Chapter 13 Bankruptcy.

Do You Qualify for Bankruptcy?

Both Chapter 7 and Chapter 13 bankruptcy have eligibility requirements. Your income must be low enough to pass the Chapter 7 means test. By contrast, in Chapter 13 bankruptcy, the amount you owe cannot exceed certain dollar limits. Also, you must have enough income to support your Chapter 13 repayment plan.

For more information on whether you qualify for bankruptcy, see The Means Test & Other Chapter 7 Eligibility Issues and Are You Eligible for Chapter 13 Bankruptcy?

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When bills become unmanageable, such as after a divorce, illness, or job loss, bankruptcy provides a filer with a financial safety net. It works by wiping out or “discharging” qualifying debt—credit card balances, overdue utility bills, personal loans, gym memberships, and more—and giving the filer a fresh start. If you’re considering filing for bankruptcy, you’ll want to learn what each chapter can and cannot do.

Individuals often file for Chapter 7 bankruptcy because it’s quick and doesn’t require debtors to repay creditors. Higher-income earners who make too much for a Chapter 7 discharge can file for Chapter 13 bankruptcy. Although a debtor must pay back some amount through a Chapter 13 repayment plan, Chapter 13 has other benefits, like preventing a home foreclosure or car repossession and reducing the amount owed on secured debt. Both bankruptcy chapters stop harassing debt collectors and put an end to wage garnishments, creditor lawsuits, and other collection actions.

Filing for bankruptcy will affect your credit score, but it will improve with time—and often far sooner than most filers expect. In fact, many people find that filing for bankruptcy repairs credit faster than would be possible otherwise.

Bankruptcy isn’t just for individuals with consumer debt problems. Filing can benefit a small business owner by minimizing personal liability after a company closure or by helping a small business return to profitability.

Finally, no one wants to file for bankruptcy. If you need bankruptcy help but have reservations, you’re not alone. Not only have employers laid off staggering numbers of workers due to the coronavirus outbreak, but companies large and small are closing at a record pace—and many businesses will seek bankruptcy relief. But that’s not as bleak as it might seem. Each fresh start—including yours—moves the economy one step closer toward recovery.

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Learn whether you can file for Chapter 13 bankruptcy.
For many debtors, Chapter 13 bankruptcy is a good option. It has provisions that will allow an individual with regular income to repay some creditors less than the amount owed while keeping all assets, including a house and car. But not everyone is eligible. Learn more about Chapter 13 bankruptcy, including who can and cannot file this bankruptcy type.

COVID-19 Update: Stimulus Proceeds Aren’t Income in Bankruptcy

Under Section 1113 of the CARES Act, “…payments made under the Federal law relating to the national emergency declared by the President under the National Emergencies Act…with respect to the coronavirus disease 2019 (COVID-19)…” are not included as part of current monthly income or disposable income when filing for bankruptcy. This temporary change will remain in effect until March 25, 2021.

Find more details, as well as links to newly-revised bankruptcy forms, in CARES Act Stimulus Payments Don’t Affect Bankruptcy Qualification.

Qualifying for Chapter 13 Bankruptcy

The benefit of this chapter is that you repay some of your debts—but usually not all—over the course of a three- to five-year repayment plan. But before the court confirms (approves) your plan, you must fill out the official bankruptcy paperwork and prove that you are:

  • up-to-date on tax filings
  • within debt amount limitations
  • employed and have enough income to cover the required monthly payment, and
  • an individual, not a business (however, all financial aspects of a sole proprietor’s business get included in the bankruptcy).
Your Income Tax Filings Must Be Current

To file for Chapter 13, you will have to submit proof that you filed your federal and state income tax returns for the four tax years prior to your bankruptcy filing date. If you need some time to get current on your filings, the court can postpone the proceedings (but you don’t want to count on this). Ultimately, however, if you don’t produce your returns or transcripts of the returns for those four years, your Chapter 13 case will be dismissed.

You Must Have Sufficient Disposable Income

To qualify for Chapter 13, you will have to show the bankruptcy court that you will have enough income, after subtracting certain allowed expenses and required payments on secured debts (such as a car loan or mortgage), to meet your repayment obligations. Your plan must pay back certain debts in full, or the judge will not confirm (approve) it and allow you to proceed. (For more information, see The Chapter 13 Bankruptcy Repayment Plan. )

You can use the income from the following sources to fund a Chapter 13 plan:

  • regular wages or salary
  • income from self-employment
  • wages from seasonal work
  • commissions from sales or other work
  • pension payments
  • Social Security benefits
  • disability or workers’ compensation benefits
  • unemployment benefits, strike benefits, and the like
  • public benefits (welfare payments)
  • child support or alimony you receive
  • royalties and rents, and
  • proceeds from selling property, especially if selling property is part of your primary business property.

If you are married, your income does not necessarily have to be “yours.” A nonworking spouse can file alone and use money from a working spouse as a source of income. And an unemployed spouse can file jointly with a working spouse.

Why File for Chapter 13 Bankruptcy?

It’s true that many people prefer to file for Chapter 7 bankruptcy because it doesn’t require the filer to pay back creditors. But some debtors simply don’t qualify. Others, however, choose to file for Chapter 13 bankruptcy because it provides options that Chapter 7 doesn’t offer, making a Chapter 13 case the better choice.

Here’s a list of common reasons a debtor might file a Chapter 13 case:

  • A debtor whose income exceeds the Chapter 7 means test maximum isn’t eligible to receive a Chapter 7 discharge and wipe out qualifying debt.
  • A homeowner who is behind on a mortgage payment can pay the arrearages over three to five years and keep the house (the same holds true for an overdue car payment).
  • A debtor can prevent a collection action such as a wage garnishment while paying off a tax bill, overdue support, or other nondischargeable debt in a repayment plan.
  • A debtor can keep nonexempt property that would otherwise get sold in a Chapter 7 bankruptcy (but the debtor will need to pay for the nonexempt portion in the three- to five-year repayment plan).
Your Debts Can’t Be Too High

You won’t qualify for Chapter 13 bankruptcy if your secured and unsecured debt exceed certain amounts. (The debt figures change every three years. You’ll find the current numbers in What Are Chapter 13 Bankruptcy Debt Limitations?)

A debt is secured if you stand to lose specific property if you don’t make your payments to the creditor. Home loans and car loans are the most common examples of secured debts. But a debt might also be secured if a creditor—such as the IRS—has filed a lien (notice of claim) against your property.

An unsecured debt doesn’t give the creditor a right to take a particular piece of property. Most debts are unsecured, including credit card debts, medical and legal bills, back utility bills, and department store charges. (Learn more by reading Types of Creditor Claims in Bankruptcy: Secured, Unsecured & Priority.)

Businesses Not Allowed in Chapter 13 Bankruptcy

A business cannot file for Chapter 13 bankruptcy in the name of that business. Businesses are steered toward Chapter 11 bankruptcy when they need help reorganizing their debts. (An exception exists, however: Although a sole proprietor cannot file in the name of the business, both business and personal debts are the responsibility of the individual, and therefore, are included in the bankruptcy filing. Therefore, Chapter 13 can effectively help reorganize a sole proprietor’s business.)

You can, however, file for Chapter 13 bankruptcy as an individual even if you own a business. You’ll include business-related debts for which you are personally liable in your Chapter 13 bankruptcy case. But, the business will remain liable for the debt. (Again, the result is different if you’re a sole proprietor—both the individual and business debt liability will be handled by the bankruptcy.)

Important Note: Stockbrokers and commodity brokers cannot file a Chapter 13 bankruptcy case, even if they want to discharge only personal (nonbusiness) debts.

How to File for Chapter 13 Bankruptcy

You’ll disclose all aspects of your financial condition, including your income and expenses, assets, creditors, and previous transactions in the official bankruptcy paperwork. The case will start once you file your forms and other necessary items, such as a filing fee and proof that you completed a credit counseling class. You’ll have fourteen days to submit your Chapter 13 repayment plan unless you receive an extension from the court.

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