Bankruptcy is a federal court process that is designed to work with both consumers and businesses to eliminate debts or repay debts under the supervision of the bankruptcy court. Two basic types of bankruptcy generally apply to consumers and businesses: Chapter 7 and Chapter 13.
Both Chapter 7 and Chapter 13 bankruptcy differ in the types of debts that are covered, who can file a particular type of bankruptcy and what property the person is allowed to keep.
Chapter 7 - Liquidating Debt
Chapter 7 bankruptcy is often referred to as liquidation, and is available to both Individuals and businesses. A Chapter 7 bankruptcy case typically has a duration of three to six months depending on the complexity of the situation.
In a Chapter 7 bankruptcy, the consumer's property is sold, or "liquidated," to pay off their debts. There are certain types of property that are exempt from being sold, but this will vary from state to state. There are instances that occur in which the person does not have any assets and all of their belongings are exempt. These are commonly referred to as "no asset" cases.
Unsecured debts are discharged. For secured debts, the consumer or business has several options:
- Allow the creditor to repossess the property;
- Keep the property by "reaffirming" the debt; or
- Keep the property by paying the creditor a lump sum for the property that is equal to its current replacement value.
There are some types of debs that cannot be eliminated through Chapter 7 however.
Not all consumers will qualify for Chapter 7. If they have a sufficient disposable income to fund a repayment plan under Chapter 13 bankruptcy, the court will not allow the person to file Chapter 7. The consumer is allowed to subtract certain expenses and monthly payments for debt to determine his or her disposable income. For instance, child support and secured property debts are often allowed to be subtracted.
Chapter 13 - Reorganizing Debt
If someone does not qualify for Chapter 7 or has a reliable source of income to repay their debts, they may be required (or may choose) to file Chapter 13. To qualify for Chapter 13, a business or consumer must meet two qualifications: secured debts must be under $922,975; and unsecured debts must be under $307,675.
When someone files for Chapter 13 bankruptcy, they must offer a repayment plan that provides details on how they plan to pay their debts off in the next three to five years. The minimum amount of money they must pay each month will depend on what they earn, how much is owed and how much their unsecured creditors would have received in a Chapter 7 case.
For secured debts under Chapter 13, the individual has the option of making up all missed payments and avoiding foreclosure or repossession or they may include their past due payments in their repayment plan to make them up over the course of the plan.
Where You Live Makes a Difference
As of October 2005, there were several important changes made to the bankruptcy law. For instance, in order to qualify for Chapter 7 bankruptcy you must meet specific eligibility requirements outlined under a "means test." If an individual's monthly income is below the state's median income, then they are eligible for Chapter 7. If their monthly income is above the state's median and they can afford to pay down their debts each month, they must file Chapter 13. Debtors must also participate in credit counseling prior to filing for bankruptcy.
Questions & Answers: Debt and Bankruptcy