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The Forms of Bankruptcy: Chapter 7 versus Chapter 13

Question: I’m looking at my bankruptcy options. What is the difference between Chapter 7 and Chapter 13 bankruptcy. 

Answer: If your financial life is spiraling out of control, with late payment fees and interest multiplying faster than you can pay, then bankruptcy might be the best option that allows you the room to piece your life back together and make a fresh start. We know that most people cringe when they hear the word bankruptcy, but the truth is that sometimes it is the best solution. Sometimes, it allows you to wipe the slate, start over, and rebuild your life faster than you otherwise could.

Six types of bankruptcy exist: Chapters 7, 9, 11, 12, 13, and 15. However, only two of these forms of bankruptcy are options for individuals, Chapters 9, 11, 12, and 15 are specialized bankruptcies for municipalities, business corporations, family farmers and fishermen, and international ancillaries, respectively.

Individuals usually file for one of two forms of bankruptcy: either Chapter 7 or Chapter 13, depending on your level of debt and the assets you are trying to keep. Chapter 7 will stay on your credit report for ten years; Chapter 13 for seven years.

Individuals, corporations, or partnerships may file for Chapter 7 bankruptcy, which is also known as liquidation or straight bankruptcy. In a Chapter 7 bankruptcy, all your assets are liquidated, and the proceeds from these sales go to your creditors.

Chapter 13 bankruptcy is intended for individuals with debts that do not exceed $1,230,650. Chapter 13 is considered less toxic to your credit score. A Chapter 13 bankruptcy involves working out a payment plan with creditors, resulting in creditors ceasing collection attempts. After you make the payments to the creditors, you can receive a discharge. The benefit of this option is that you can retain a leased car or a mortgaged house, but you need to repay all your remaining debts over a three- to five-year period or else creditors will confiscate your assets.

Because bankruptcy is such a complex process, it is highly recommended that you hire an attorney to discuss the two different forms of bankruptcy and which is right for you. Bankruptcy has important implications for your finances and for your legal status, so having an experienced bankruptcy lawyer can prevent you from making serious mistakes. For example, an attorney might be able to advise you about property that is exempt from asset collection in bankruptcy. As well, an experienced attorney can help you answer the important question: “Should I file for bankruptcy?”

If you so choose, you may be able to file on your own, or pro se. Be prepared to do a lot of work to research the bankruptcy code and any special laws unique to your state or county. We don’t usually recommend filing pro se, which is for people who have experience with filing bankruptcy and who have a relatively simple bankruptcy and few or no at-risk assets.

If you are filing for Chapter 7 bankruptcy, you might want to ask your attorney about reaffirming part of your debt, a process that will allow you to preserve a debt through bankruptcy so that you can pay it off. It might sound strange to consider keeping a debt.

What? you might be thinking. Reaffirm a debt? Isn’t bankruptcy an opportunity to wipe the slate clean?

It is, but reaffirming a debt might have some benefits. Some proponents of this strategy argue that if you continue to pay on one or two of your existing accounts, you will help your credit score by showing credit-scoring bureaus that you did not shirk all your debt. Reaffirming a debt that is in good standing may help you in some circumstances, such as when you have a small amount on a credit card you have had for several years. By keeping the debt, you will keep the account active and thereby take advantage of the age of the account. (Credit-scoring bureaus assign 15 percent of your credit score to the length of time of your credit accounts.)

However, if you reaffirm too many debts, you will miss the best opportunity offered by bankruptcy: a chance to start over without bearing the weight of your previous debts. Reaffirming debt is a complicated decision, yet another reason to meet with a qualified attorney.

If you are considering bankruptcy, be sure to do your homework and make the best decision for your situation. If you are unable to avoid bankruptcy, being strategic as you work through the process will help you gain some control in your life and start working for a brighter future. And, of course, don’t forget to start the process of rebuilding credit after a bankruptcy!