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One of the first questions during every bankruptcy consultation is what is the difference between Chapter 7 and Chapter 13? This article will discuss many (but not all) of the differences.
The most common difference between the two is the debtors obligations to the court. In Chapter 7, or what is called a liquidation proceeding, a court looks at the debtors assets to satisfy creditors claims. If a debtor owns assets free and clear, or if there is considerable equity in assets, the court will liquidate those assets, take the funds and pay creditors with them. In Virginia, you can file a liquidation proceeding and not lose assets if your assets value are less than the current exemption levels for debtors. For instance, if you have a car that is worth $5000 with no lien, you would not lose that car if you filed Chapter 7 because the value is under Virginia's $6000 automobile exemption. By contrast, if you owned a car worth $20,000 with no lien, the Court would take your car, sell it, pay you what was protected under exemptions claimed and then give the balance to creditors.
In Chapter 13, the focus is not liquidating assets (although this can voluntarily occur of the debtor choses), but instead repaying creditors from future debtor income. As Chapter 7 is called a liquidation proceeding, Chapter 13 is referred to as a wage earner repayment plan. Ultimately, there are many factors that go into a Chapter 13 wage earner plan that determine the amount of payments required and the term of the plan (3-5 years). But ultimately, the purpose of Chapter 13 is to attempt to repay a portion of your unsecured debt over time while retaining assets that may be subjected to liquidation in Chapter 7. After I give this very cursory review of the two chapters, the next big question from clients generally is, can I pick which chapter I file? Well, not exactly. In order to file Chapter 7, a means test has to be passed. In order to pass the means test, the Court averages your past 6 months of income to determine what your average income is. Now the court will do this for spouses as well, even if the spouse is not filing bankruptcy. The purpose of the means test is to look at total household income vs. family size. Here are the numbers for Virginia for the means test: http://www.legalconsumer.com/bankruptcy/means-test/state.php?st=VA Now, looking at the chart, say you have a family of 4 (you, your spouse, and two kids), then when we add all the income of the family and divide it by 6, then that number MUST be less than $7690 per month. Some income is excluded, but the means test factors almost all income, even retirement. So if your household income (gross -before taxes) averages $7690 or less, you can file a Chapter 7. If it is $7691 or more, you fail the means test. This does not mean you cannot still file a Chapter 7. However, there has to be a substantial and compelling reason as to why you should be able to file. The most common one is where someone is a high wage earner and retiring or has become disabled and no longer presently produces the income they had earlier in the year. If you fail the means test, you have to work closely with your attorney on whether you can file Chapter 7. If you do fail the means test, then you generally must file a Chapter 13 case and pledge your disposable income to creditors over a 5 year period. Disposable income is generally defined as the difference between your net take home income and your living expenses. So, if you take home $5000 per month, and your expenses to live (rent, utilities, food, insurance, vehicle, etc) total $4500 per month, then you would pay back $500 per month to your creditors for 60 months. What you pay back is strictly a factor of your income and expenses, not how much you owe So in this scenario, you would pay $500 per month if you owed $40,000 or $150,000. We are not trying to repay debts in full in Chapter 13 (although sometimes that does happen), we are pledging as much as possible to creditors over a fixed period of time.
In addition to pledging your disposable income, you still have to pay secured creditors either in Chapter 7 or Chapter 13. A secured creditor is a creditor that has a lien on an asset. Most commonly, they are mortgages, car loans or furniture loans. In order to deal with secured creditors, you either need to pay for them or surrender them. Both chapters are the same for secured creditors except that you may be able to pay some non-mortgage secured creditors in a Chapter 13 plan at a substantially reduced interest rate. As of the date of this article, the current interest rate is 5.25%. So if you have a high loan rate on a car, Chapter 13 may be a good option to modify that interest rate. This can only be done in Chapter 13. In Chapter 7, you cannot compel a creditor to reduce their interest rate on a car loan or furniture account. By reducing the interest rate of a high car loan, it generally can lower your payment and give you more funds to spread to other creditors. If you pass the means test, you also still can file Chapter 13, and instead of pledging 5 years of disposable income to creditors you only have to pledge 3. In the previous example of $500 per month, you would only pay for 3 years. Again, we are not worried about how much debt you have. Many people voluntarily file Chapter 13 because they have the ability to repay some of their debt or they want to take advantage of reducing interest rates on cars or furniture, or reorganizing mortgage arrears to avoid a foreclosure. A Ch 13 plan can also repay taxes without interest or penalties. Many people who have fought with the IRS for years with interest and penalties on taxes can find safe haven from interest and penalties in Chapter 13 if they can repay their tax over a 3-5 year period. Chapter 13 also has something called a super-discharge which means you can discharge certain debts in Chapter 13. Most common are debts to ex-spouses arising out of property settlement debts ordered in a divorce proceeding. Many people who are in Chapter 13 bankruptcy have changes of circumstances. If such a change is negative, such as a loss of income or loss of job, then the debtor can convert their chapter 13 case to chapter 7. You are not "locked" into a Chapter 13. If your circumstances improve and you can pay more, we will amend your case to increase your payment. If they become worse, and you can no longer afford a repayment plan, then we can convert to Chapter 7. Chapter 13 is a very flexible bankruptcy to modify and get out of if necessary. Finally, many people have filed Chapter 7 recently and they need to file bankruptcy again. If you have previously filed a Chapter 7 case, you can file a Chapter 13 at anytime to deal with creditors. However if you file within the first 4 years of your previous Chapter 7 case case, you will not get a discharge in Chapter 13. By way of example, say you filed Chapter 7 about 3 years ago. You have a car that is ready to be repossessed. In such a scenario, you can file Chapter 13 to repay the car over time. You will not be discharged from the debt, but you can file to stop creditors from taking your things or garnishing your wages. For further information about bankruptcy, please feel free to contact my office. 877-214-9640. _ Attorney Tim Anderson 9/16/14