In order to know which bankruptcy to file for your specific situation, you need to know some basics about both Chapter 7 and Chapter 13.

Chapter 7

Chapter 7 is commonly known as “liquidation.” A Chapter 7 may be filed by an individual, a married couple, a sole proprietorship or a corporation. A married person may either file alone or with their spouse as circumstances dictate.

In a chapter 7 case, the debtor is allowed to retain all of the property that he or she owns that is “exempt.” That is, each State determines how much real estate and personal property one may retain in a bankruptcy proceeding that takes place within that State. Any property the debtor owns which is in excess of the values the State declares to be exempt is sold by the bankruptcy trustee and the proceeds of the sale are given to the creditors.

In Indiana there are several exemptions that the debtor is entitled to. Two of the more commonly used exemptions are the “residential real estate exemption” and the “personal property exemption.” These exemption amounts changed effective July 1, 2005 to the debtor’s advantage. A person filing bankruptcy in Indiana may retain up to $15,000.00 equity in real estate in which the debtor or a dependent of the debtor resides, and may retain up to $8,000.00 of personal property. Married couples are each individually entitled to these exemption amounts, so a married couple filing bankruptcy jointly can actually protect up to $30,000.00 equity in real estate and $16,000.00 of personal property. These same exemptions apply in both Chapter 7 and Chapter 13 cases.

Debts which are generally dischargeable by a Chapter 7 include medical bills, credit cards, utility bills, personal loans, signature loans, mortgages (if the real estate is surrendered), car loans (if the car is surrendered), deficiency balances due after the sale of a repossessed vehicle, and most other consumer debt even if those debts have become a judgment from a lawsuit (it is not usually true that once someone sues you that you can no longer file bankruptcy on the debt, but sometimes the lawsuit makes the debt have to be treated differently in the bankruptcy if you own real estate).

Debts which are not generally dischargeable by a Chapter 7 case include taxes that are less than three years old, student loans (unless the debtor can show that repayment of the student loans will cause an undue hardship on the debtor or a dependent of the debtor—this is a very tough thing to show), debts obtained by fraud, debts incurred from accidents involving alcohol or drugs, debts incurred from willful or malicious behavior, child support, alimony, criminal restitution, and certain other specifically defined types of debt.

When one files a Chapter 7, all of his or her dischargeable debts are wiped out, and then the debtor decides if there are any debts that he or she would like to retain. Debts are retained in a Chapter 7 by the debtor signing a “reaffirmation agreement,” which is an agreement that says that the debtor voluntarily waived his or her right to discharge of the particular debt that is being reaffirmed in return for some compensation, which is normally the right to continue to have possession of some piece of collateral. For example, when one files Chapter 7 his or her mortgage is discharged, but if the debtor wants to retain the home he or she signs a reaffirmation agreement indicating that he or she will retain the debt and keep making the mortgage payments according to the original agreement so long as the bank allows him or her to retain the home. It is common for debtors to reaffirm debts for car loans and homes in order to retain those items.

Reaffirming debts: Banks normally require the debtor be current on the loan in order to reaffirm the debt, so if one files Chapter 7 and is behind on his or her mortgage payments, he or she may not be able to keep the home unless he or she can get the loan current within a very short time. Reaffirmation agreements are binding unless they are withdrawn by the debtor within 60 days of the date on which the agreement if filed with the court, or prior to the Order of Discharge being issued, whichever occurs later. So, once the deadline to withdraw the reaffirmation expires, the debtor is locked into the reaffirmed debt, and if the debtor later discovers that he or she cannot afford to repay the loan the bankruptcy filing will provide no protection to the debtor if the bank sues the debtor or repossesses the collateral. Therefore, one should never reaffirm a debt, even for a house or car, unless one is absolutely certain he or she will be able to afford all of the payments on the reaffirmed loan.

The typical Chapter 7 case takes three to four months to complete, with the debtor being required to attend only one brief hearing in most cases. At the hearing, the bankruptcy trustee, or the debtor’s attorney in some jurisdictions will ask the debtor a series of questions in order to decide if there are any issues in the bankruptcy case. If there are no issues, the debtor will receive an Order of Discharge from the court in the mail around 60-70 days after the date of the hearing, at which time the case is complete and the discharged debts are wiped out.

After the bankruptcy case is complete, the debtor is responsible to pay only those debts which are not dischargeable by Chapter 7 such as child support and taxes that are less than three years old and any debts that the debtor voluntarily reaffirmed such as car loans and mortgages.

You would choose Chapter 7 and not Chapter 13 when the following are true:
1. You don’t have any assets that you’d have to surrender to a trustee.
2. You are current on home and car payments, or willing to give them up.
3. You don’t have much money left over each month after paying expenses.
4. You have not received a bankruptcy discharge in an earlier Chapter 7 case filed within the past eight years.

The main obstacle to Chapter 7 is the Means Test, a creation of the new bankruptcy law put into effect in October 2005. The Means Test does not apply to debtors earning less than the median income for their state, and most of those earning more than the median are still able to pass.

CHAPTER 13

Chapter 13 is commonly referred to as a wage earner plan or reorganization. A Chapter 13 may be filed by an individual, a married couple or a sole-proprietorship, but may not be filed by a corporation. Married persons may either file alone or with their spouse.

In a Chapter 13 case, the debtor pays back a portion of their debt over three to five years, based on what the debtor can afford to pay. The debtor does this by first proposing a “Chapter 13 Plan” to the court, which indicates the amount the debtor will pay each month and for how long. This money is paid to the bankruptcy trustee assigned to the debtor’s case, and the bankruptcy trustee disburses the money to all of the creditors according to the Chapter 13.

Generally, all of the debtor’s debts, including medical bills, credit cards, car loans, taxes, and virtually every other type of debt, are lumped together in the Chapter 13 Plan, so that the debtor will only have to pay one payment each month, which is the Chapter 13 Plan. The only common exception to this is mortgages, which in some divisions continue to be paid outside the Chapter 13 Plan directly by the debtor to the bank.

Even though all or most of one’s debts are lumped together into the Chapter 13 Plan payment, the amount of the payment is often considerably less than the sum of all of the individual payments the debtor was making prior to filing the Chapter 13, for several reasons: First, the debtor has to pay only a small percentage of the unsecured debt depending on what the debtor can afford to repay, and unsecured debts do not get paid any interest in a Chapter 13 Plan. So, if you owe $24,000.00 in medical bills and were paying them at 8% interest before you filed a Chapter 13, in the Chapter 13 Plan you would have to pay a tiny part of that total bill, at no interest. The remaining unpaid portion of the medical debt is discharged and may never be collected by the creditor. Second, the debtor has to pay only the face amount of collateral unless the collateral was recently purchased, not the total amount owed, for secured debts excluding mortgages, and has to pay only a reasonable interest rate on the secured items. So, if you owe $14,000.00 at 18% interest on a vehicle prior to filing Chapter 13, and the vehicle is worth only $5,000.00, in a Chapter 13 Plan the debtor would have to pay only $5,000.00 at a much lower interest rate (prime rate plus 1-3% risk factor) in order to keep the car, and the remaining unpaid balance of $9,000.00 would be discharged. In this way, a Chapter 13 Plan can take you out of a situation where you were paying unreasonably high monthly payments and put you into a quite manageable single payment without you having to lose your car.

In Chapter 13, one may pay taxes which are nondischargeable through his or her Chapter 13 Plan without being assessed any further interest or penalties. One may also include past due amounts on a mortgage in a Chapter 13 Plan, and the bank is forced to treat the debtor as if he or she is current on the mortgage so long as the debtor does not miss any further mortgage payments. In this way, debtors may stop foreclosure proceedings on their home and get the missed mortgage payments caught up within a reasonable budget.

The exemptions that apply in a Chapter 7 case also apply in Chapter 13 cases, but even if a debtor is over the exemption limits in a Chapter 13 case, he or she can still hang on to all of their unexempt property without fear that the bankruptcy trustee will sell the property if he or she arranges the Chapter 13 Plan appropriately. This is normally done by increasing the amount of the Chapter 13 payment until the bankruptcy trustee is satisfied that he or she is receiving enough money through the Chapter 13 Plan that selling the unexempt property is no longer necessary.

Debts which are generally dischargeable by a Chapter 13 include medical bills, credit cards, utility bills, personal loans, signature loans, mortgages if the real estate is surrendered, car loans if the car is surrendered, deficiency balances due after the sale of a repossessed vehicle, and most other types of consumer debt even if those debts have become a judgment from a lawsuit, unless you own real estate.

Debts which are not usually dischargeable by a Chapter 13 case include taxes that are less than three years old, student loans unless the debtor can show that repayment of the student loans will cause an undue hardship to the debtor or a dependent of the debtor, and this is a very tough thing to show, debts incurred from accidents involving alcohol or drugs, child support, alimony, criminal restitution, and certain other specifically defined types of debt.

Even though some types of debt are not dischargeable by Chapter 13 or any other bankruptcy chapter, those debts can often be brought up to date and paid off through a Chapter 13 Plan.

The typical Chapter 13 case requires that the debtor appear at only one brief hearing in most cases, though Courts may soon go to two hearings (a Meeting of Creditors and a Confirmation Hearing). At the hearing, the bankruptcy trustee will ask the debtor a series of questions to determine if there are any issues in the case. If there are no issues, or after any issues are resolved, the court will normally deliver an “Order of Confirmation” to the debtor in the mail. The Order of Confirmation is the court’s approval of the Chapter 13 Plan.

After completing one’s Chapter 13 Plan, the payments of which must between three to five years, the debtor will receive an Order of Discharge from the court in the mail. Upon receiving the Order of Discharge, the case is complete.

After the case is over, the debtor will be responsible to pay only those debts which were not dischargeable by the Chapter 13 Plan such as child support or not paid off through the Chapter 13 Plan such as mortgages and student loans and almost all taxes.

Every Chapter 13 Plan must satisfy two tests: the best-interest test and the best-efforts test. Under the Best-interest test, unsecured creditors must receive at least as much as they’d get when you file a Chapter 7 bankruptcy rather than a Chapter 13. If all your property is exempt and unsecured creditors would receive nothing in a Chapter 7, the best-interest test isn’t a factor. On the other hand, when you have nonexempt property, your plan must propose to pay at least that much. Under the best-efforts test, you must pay all your disposable income (what’s left over after paying reasonable living expenses) to the trustee for at least the first 36 months of the Plan.

DECIDING WHICH CHAPTER TO USE—CHAPTER 7 OR 13

Under the new bankruptcy law that went into effect in October 2005, in some circumstances you may not be permitted to file under Chapter 7 and in some cases Chapter 13. Congress has created two new tests to help determine which chapter someone should file under—the Median Income Test and the Means Test. If one’s income exceeds the median income for his or her state, the person might have to file under Chapter 13.

If a person has received a prior bankruptcy discharge from a Chapter 7 that was filed within the past eight years, that person is not eligible to file Chapter 7. If a person has received a prior bankruptcy discharge from a Chapter 13 that was filed within the past four years, that person is not eligible to file Chapter 7. In that case, the only option for that person is Chapter 13.

If the person seeking to file bankruptcy does not have a steady source of income from which to pay his or her Chapter 13 Plan payment, that person is not allowed to file a Chapter 13 and therefore may file only a Chapter 7.

If one’s regular monthly income exceeds his or her regular monthly expenses by $166.66 or more, that person must file a Chapter 13.

There are other factors in deciding which bankruptcy chapter to file, including whether one owes back child support. If so, then that person can file Chapter 7 but would not do so, because he would lose all of his assets and then have his assets seized and sold to pay the back child support. For this reason, a person who owes back child support will almost always file Chapter 13 rather than 7.

Another factor to consider in choosing which bankruptcy chapter to file is whether one is current on the collateral (home or vehicle) that secures your loan or loans. Typically, you must be current on the loan to reaffirm a debt under a Chapter 7 case. But if you are behind (delinquent) on your vehicle or house payments, that is not a problem in a Chapter 13 case—you can pay off your delinquent payments in the Chapter 13 Plan.

Another factor is whether one is within the exemption limits on property one wishes to retain. If the value of one’s personal property or equity in one’s personal residence exceeds his or her exemptions, those items will be sold by the bankruptcy trustee in a Chapter 7 case, whereas those items may be protected by filing Chapter 13 and arranging the terms of the Chapter 13 Plan correctly.

Another factor in deciding which bankruptcy chapter is right for you is if you own a vehicle for which you owe more for your car is worth. If you do owe more for your car loan than your car is worth, and you are filing a Chapter 13 case, then you have to pay only the value of the car or the amount owed, whichever is less as long as the collateral was not too recently purchased. So, a Chapter 13 debtor could keep the car by paying only the value of the car, while the remaining balance is discharged by the Chapter 13 Plan. In contrast, if the person was filing a Chapter 7, then the debtor must reaffirm the debt for the original contract terms in order to keep the vehicle, or the debtor may redeem the car for the fair market value, which requires a new loan at usually a high interest rate.

You should choose a Chapter 13 bankruptcy when any of the following are present:
1. You need to catch up on your mortgage payments.
2. You need to catch up on past-due child support.
3. You need to catch up on taxes that you want to pay off without interest and penalties.
4. You had a bankruptcy within the past eight years.
5. You earn enough money to pay monthly expenses with ease and want to do your best to repay creditors at least some amount.

Advantages of Chapter 13

1. A Chapter 13 bankruptcy can save your house from going to foreclosure. It can get your house payments caught up and stretched out over the life of the Chapter 13 Plan.
2. Your overdue child support can be stretched out and paid off over three to five years.
3. You can pay taxes over time and possibly without interest and further penalties.
4. You can reduce payments on some secured loans to the value of the collateral.
5. You can keep nonexempt property.
6. You can get bankruptcy relief now rather than having to wait a full eight years in certain cases.

There are other issues to discuss on this point that are best left to a face-to-face discussion with one’s attorney. Suffice to say, the new bankruptcy law has made the choice to file a Chapter 7 versus a Chapter 13 a difficult decision, so a person considering bankruptcy will do well to consult a bankruptcy attorney.