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Bankruptcy

Bankruptcy is a federal court process designed to help consumers and businesses eliminate their debts or repay them under the protection of the bankruptcy court. Bankruptcies can generally be described as "liquidations" or "reorganizations."

Chapter 7 bankruptcy is the liquidation variety: If you own property that isn't exempt under your state's laws, it may be taken and sold ("liquidated") to pay back some of your debt. Chapter 13 bankruptcy is the most common type of "reorganization" bankruptcy for consumers: You get to keep all of your property, but you must make monthly payments over three to five years to repay all or some of your debt.

Both kinds of bankruptcy have numerous rules -- and exceptions to those rules -- about what kinds of debts are covered, who can file, and what property you can and cannot keep.

Chapter 7 Bankruptcy

Chapter 7 bankruptcy can be filed by individuals (called a "consumer" Chapter 7 bankruptcy) or businesses (called a "business" Chapter 7 bankruptcy). A Chapter 7 bankruptcy typically lasts three to six months.

Property liquidation. In Chapter 7 bankruptcy, some of your property may be sold to pay down your debt. In return, most or all of your unsecured debts (that is, debts for which collateral has not been pledged) will be erased. You get to keep any property that is classified as exempt under the state or federal laws available to you (such as your clothes, car, and household furnishings). Many debtors who file for Chapter 7 bankruptcy are pleased to learn that all of their property is exempt.

Secured debt. If you owe money on a secured debt (for example, a car loan for which the car is pledged as a guarantee of payment), you have a choice of allowing the creditor to repossess the property; continuing your payments on the property under the contract (if the lender agrees); or paying the creditor a lump sum amount equal to the current replacement value of the property. Some types of secured debts can be eliminated in Chapter 7 bankruptcy.

Eligibility for Chapter 7. Not everyone can file for Chapter 7 bankruptcy. For example, if your disposable income is sufficient to fund a Chapter 13 repayment plan -- after subtracting certain allowed expenses and monthly payments for certain debts -- you won't be allowed to use Chapter 7 bankruptcy. For more on this and other requirements, see Chapter 7 Bankruptcy -- Who Can File?

Bankruptcy doesn't work on some kinds of debts. Though bankruptcy can eliminate many kinds of debts, such as credit card debt, medical bills, and unsecured loans, there are many types of debts, including child support and spousal support obligations and most tax debts, that cannot be wiped out in bankruptcy. For more information, see What Bankruptcy Can and Cannot Do.

For more information on Chapter 7 bankruptcy, see How to File for Chapter 7 Bankruptcy, by attorney Stephen Elias, attorney Albin Renauer, and Robin Leonard, J.D. (Nolo).

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Chapter 13 Bankruptcy

Chapter 13 bankruptcy is also known as "wage earner" bankruptcy because, in order to file for Chapter 13, you must have a reliable source of income that you can use to repay some portion of your debt.

Repayment. When you file for Chapter 13 bankruptcy, you must propose a repayment plan that details how you are going to pay back your debts over the next three to five years. The minimum amount you'll have to repay depends on how much you earn, how much you owe, and how much your unsecured creditors would have received if you'd filed for Chapter 7 bankruptcy.

Debt limits. Your debts must be within limits set by the federal government: Currently, you may not have more than $1,010, 650 in secured debt and $336,900 in unsecured debt.

Secured debts. If you have secured debts, Chapter 13 gives you an option to make up missed payments to avoid repossession or foreclosure. You can include these past due amounts in your repayment plan and make them up over time.

For more information on Chapter 13 bankruptcy, see Chapter 13 Bankruptcy: Repay Your Debts, by attorney Stephen Elias and Robin Leonard, J.D.

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Other Types of Reorganization Bankruptcy

In addition to Chapter 13 bankruptcy, there are two other types of reorganization bankruptcy: Chapter 11 and Chapter 12.

Chapter 11 bankruptcy. Chapter 11 is typically used by financially struggling businesses to reorganize their affairs. It is also available to individuals, but because Chapter 11 bankruptcy is expensive and time-consuming, it is generally used only by those whose debts exceed the Chapter 13 bankruptcy limits (rare) or who own substantial nonexempt assets (such as several pieces of real estate). If you are considering Chapter 11 bankruptcy, you'll need to talk to a lawyer.

Chapter 12 bankruptcy. Chapter 12 is almost identical to Chapter 13 bankruptcy. But to be eligible for Chapter 12 bankruptcy, at least 80% of your debts must arise from the operation of a family farm. Chapter 12 bankruptcy has higher debt ceilings to accommodate the large debts that may come with operating a farm, and it offers the debtor more power to eliminate certain types of liens. Very few people use Chapter 12 bankruptcy; if you want to join their ranks, you should consult with a lawyer.

© 2010 Nolo

Bankruptcy FAQ (Chapter 7 and Chapter 13)


Chapter 7 bankruptcy and Chapter 13 bankruptcy: what you need to know.

What's Below:

What exactly is bankruptcy? Will it wipe out all my debts?

What is the difference between Chapter 7 and Chapter 13 bankruptcy? Which one lets me keep my property?

Am I free to choose between Chapter 7 bankruptcy and Chapter 13 bankruptcy? Which type of bankruptcy should I use?

What exactly is bankruptcy? Will it wipe out all my debts?

Bankruptcy is a federal court process designed to help consumers and businesses eliminate their debts or repay them under the protection of the bankruptcy court. Bankruptcies can generally be described as "liquidation" (Chapter 7) or "reorganization" (Chapter 13). Under a Chapter 7 bankruptcy, you ask the bankruptcy court to wipe out (discharge) the debts you owe. Under a Chapter 13 bankruptcy, you file a plan with the bankruptcy court proposing how you will repay your creditors. You must repay some debts in full; others may be repaid only partially or not at all, depending on what you can afford.

When you file either kind of bankruptcy, a court order called an "automatic stay" goes into effect. The automatic stay prohibits most creditors from taking any action to collect the debts you owe them unless the bankruptcy court lifts the stay and lets the creditor proceed with collections.

Certain debts cannot be discharged in bankruptcy; you will continue to owe them just as if you had never filed for bankruptcy. These debts include back child support, alimony, and certain kinds of tax debts. Student loans will not be discharged unless you can show that repaying the debt would be an undue burden, which is a very tough standard to meet. And other types of debts might not be discharged if a creditor convinces the court that the debt should survive your bankruptcy.

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What is the difference between Chapter 7 and Chapter 13 bankruptcy? Which one lets me keep my property?

In Chapter 7 bankruptcy, you ask the bankruptcy court to discharge most of the debts you owe. In exchange for this discharge, the bankruptcy trustee can take any property you own that is not exempt from collection (see below), sell it, and distribute the proceeds to your creditors.

In Chapter 13 bankruptcy, you file a repayment plan with the bankruptcy court to pay back all or a portion of your debts over time. The amount you'll have to repay depends on how much you earn, the amount and types of debt you owe, and how much property you own.

You lose no property in Chapter 13 bankruptcy, because you fund your repayment plan through your income. In Chapter 7 bankruptcy, you select property you are eligible to keep from a list of state exemptions. Although state exemption laws differ, states typically allow you to keep these types of property in a Chapter 7 bankruptcy:

  • Equity in your home, called a homestead exemption. Under the Bankruptcy Code, you can exempt up to $20,200 of equity. Some states have no homestead exemption; others allow debtors to protect all or most of the equity in their home.
  • Insurance. You usually get to keep the cash value of your policies.
  • Retirement plans. Most retirement benefits are protected in bankruptcy.
  • Personal property. You'll be able to keep most household goods, furniture, furnishings, clothing (other than furs), appliances, books and musical instruments. You may be able to keep jewelry only worth up to $1,000 or so. Most states let you keep a vehicle as long as your equity doesn't exceed several thousand dollars. And many states give you a "wild card" amount of money -- often $1,000 or more -- that you can apply toward any property.
  • Public benefits. All public benefits, such as welfare, Social Security, and unemployment insurance, are fully protected.
  • Tools used on your job. You'll probably be able to keep up to a few thousand dollars worth of the tools used in your trade or profession.
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