Why file a Chapter 13 Bankruptcy when you qualify for Chapter 7?

January 30, 2019

A Chapter 7 bankruptcy is a liquidation bankruptcy, which in essence wipes out most of an individual’s general unsecured debts (i.e., credit card and medical bills) without a need to pay the balances through a repayment plan.  A Chapter 13 bankruptcy is a bankruptcy that reorganizes an individual’s debt and creates a monthly repayment plan that repays at least a portion of the debt over a period of three to five years.  The easiest way to qualify for a Chapter 13 bankruptcy is to not qualify for a Chapter 7, meaning, an individual would need to make more than the median income. In Michigan, the median household income from 2017 was $54,909. However, a Chapter 13 bankruptcy is not limited to only individuals who do not qualify for a Chapter 7 bankruptcy.

A Chapter 13 bankruptcy has a few more advantages than a Chapter 7 bankruptcy. For example, an individual who is behind on their mortgage has the ability to catch up on missed mortgage payments and prevent the possibility of a foreclosure action. An individual behind on car loan payments also has the option to restructure their debt to get caught up on missed car payments and prevent a possible repossession. This is not true under a Chapter 7 bankruptcy, in a Chapter 7 bankruptcy an individual is not able to catch up on missed payments. Therefore, the possibility of repossession or a foreclosure is still possible. Under a Chapter 13 bankruptcy, an individual is able to restructure their debt in a way to keep maintaining their payments as well as pay any possible arrears in order to get caught up and avoid the possible repossession or foreclosure.

When an individual falls behind on their mortgage, they have the benefit of filing for a Chapter 13 bankruptcy in order to prevent a foreclosure. Additionally, if the individual’s home is worth less than the first mortgage, any junior mortgages would be “stripped” away. Under a bankruptcy, those junior mortgages would be considered “wholly unsecured” and as such they could be stripped. Those junior mortgages would be treated the same as other unsecured debts and at the end of the bankruptcy, would be discharged the same as the other unsecured debts.

Another benefit to a Chapter 13 bankruptcy is that an individual will be able to keep all of their property under the bankruptcy, even if some is unexempted. In a Chapter 7 bankruptcy, property would need to be exempt in order for the individual to be able to keep their property. If an individual’s property cannot easily be exempt, for example, if an individual has a lot of valuable property or a lot of equity in their homes, then the individual’s total property may not be exempt. Any amount that is not exempt, the individual is required to either hand the property over to the trustee so that the trustee can sell it, or pay the trustee the monetary value in order for the individual to be able to retain possession. Whereas an individual filing for a Chapter 13 bankruptcy is able to retain possession of all property but must pay unsecured creditors an amount (typically pennies on the dollar) equal to the value of nonexempt assets through a process called the Liquidation Analysis.

Additionally, if someone owes significantly more on a vehicle than it is worth, they can “cramdown” the debts to its’s Fair Market Value (FMV).  This “cramdown” is allowed in Chapter 13 cases, as opposed to a Chapter 7. In order to utilize this process, the loan must have been acquired at least 910 days prior to the bankruptcy. This way, an individual who goes out and buys a new car and acquires a loan cannot turn around and file for bankruptcy in order to lower the loan.

So while there are a ton of advantages to filing a Chapter 7 bankruptcy, an individual may be more inclined to file a Chapter 13 bankruptcy, especially if a foreclosure or repossession is possible. It is good to check each individual’s needs in terms of what they are looking to get out of the bankruptcy, and not just to get out of debt.