When a person faces bankruptcy because of personal debts, the two main options are Chapter 7 and Chapter 13. The difference between the two is the liquidation of assets to settle the debts (Chapter 7) versus a payment plan to pay the debts (Chapter 13).
Approximately 20 percent of all consumer bankruptcy filings fall under Chapter 13. Known as wage earner's bankruptcy, Chapter 13 allows a debtor with a steady income to pay all or part of the debts over a period of time, usually three years but as long as five. It is usually filed by people who are past due in the home mortgage or car payments.
To qualify for Chapter 13, the debtor must have less than $250,000 in unsecured debt (credit cards) and less than $750,000 in secured debts (mortgages and car loans). A person with debts greater than these must file under Chapter 7 or, in some cases, Chapter 11.
When filing under Chapter 13, the debtor submits to the bankruptcy court a proposed payment plan that applies all of his or her disposable income to paying the creditors. Disposable income is the monies available after the expenses of shelter, food, and other necessities are met.
The plan is usually sent to the person's creditors for review. If they find the plan acceptable and the court approves the plan, it becomes effective. Normally, the debtor sends a set monthly amount to a court-appointed trustee who distributes it to the creditors. This is usually accomplished by the debtor's employer's withholding the payment and forwarding it to the trustee.
Several advantages exist to filing under Chapter 13 rather than Chapter 7. A cosigner to a debtor's consumer obligation is protected by a stay under Chapter 13, unless the plan will not retire the entire debt. The discharge or elimination of debts under Chapter 13 is broader than under Chapter 7. For example, if the debtor completes the payment plan, the creditor usually cannot demand any remaining debt. However, debts secured by collateral may still be collected.
A person may file under Chapter 13 repeatedly unless prohibited by the court, while filings under Chapter 7 may occur only every six years. Finally, future creditors may be more agreeable to extend credit to someone with a Chapter 13 filing on his or her credit report rather than a Chapter 7 filing because a larger percentage of the debt was most likely paid.
While Chapter 13 is the preferred option over Chapter 7, it does have a high failure rate. The key is a realistic payment plan, and a financial advisor or bankruptcy attorney can help in this area.