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When is it Preferable to File a Chapter 13 bankruptcy vs. Chapter 7?
First let’s talk about what the basic difference is. Chapter 7 is liquidation of debts. In a Chapter 7 bankruptcy all your debts other than debts which you specifically reaffirm such as a car loan, or a home mortgage, or debts which are not dischargeable, such as federal taxes, or student loans, all other debts are discharged. Whereas in a bankruptcy, the unsecured debts or some portion of them, typically a small portion of them is paid off over a period of time three to five years.
So taking that fundamental distinction between Chapter 7 and 13 into consideration what are some reasons why a Chapter 13 might be preferable? Well, I’ve listed five and not necessarily in any particular order.
First of all, someone’s behind in their mortgage or their car loan they want to make up the payments but the bank is saying no, you’ve got to pay it all at one time. In a Chapter 13 bankruptcy, the court can require that the lender accept the payment of the backdue payment over a three to five year period during the course of the plan.
Another, number two would be if you have a tax obligation or student loan which is not dischargeable in a Chapter 13 bankruptcy, the creditor whether it be the IRS or the student loan lender is required to accept whatever payments the judge approves within the Chapter 13 plan. Which may be significantly less than what you would otherwise have to pay.
Number three, you’ve got non-exempt property. In a Chapter 7 bankruptcy, there’s certain property that you can keep, that’s property that’s exempt. Any property that’s not exempt, you have to give up to the trustee. And they’re going to sell it, they’re going to use it, to pay creditors.
In a Chapter 13, you get to keep that property and whatever amount the creditors otherwise would have gotten, you pay over that three to five year period as part of the plan.
Number four, you’ve got a co-debtor on your debt. Say, mom or dad co-signed your loan. And if you discharge the loan in a Chapter 7 bankruptcy the creditors then going to be looking to the co-debtor to collect the money. In a Chapter 13, you can pay some portion of that debt over time and as long as the automatic stay or freeze is in effect, the creditor can do nothing to go after the co-debtor.
Number five, let’s say you own investment or rental property, that you’re deeply under water. What the bankruptcy court can do is to cramdown the mortgage. In other words to reduce the mortgage down to the actual value of the property and then that crammed down amount is then put over into unsecured debt and ultimately gets discharged along with the unsecured debt.
And if you’re in a Chapter 13 plan, this is what we call a zero payment plan. In other words there’s no payments, zero payments going to unsecured creditors, then all of that debt is going to be discharged.
So if you can get close to a zero payment plan in a Chapter 13 and you take advantage of the five situations that I just referred to, it can be dramatically better than going through a Chapter 7.