A Rule of Thumb about Chapter 7 vs. Chapter 13

If you qualify for both Chapter 7 and 13, look closely at how much you’d be helped by Chapter 13 before choosing Chapter 7 merely because it’s simpler.

 

The main point of the last blog was that Chapter 7 and 13 each have their advantages and disadvantages—some of which may not be obvious—so it’s smart to be open-minded when you come in to get legal advice about them.

Assuming you qualify for both options, the choice truly does depend on your personal, unique combination of circumstances. AND it depends on YOUR personal goals within those unique circumstances.

But here’s a broad rule of thumb:

File a Chapter 7 straight bankruptcy unless the many extra tools that Chapter 13 provides makes filing that worthwhile instead.

This does NOT mean that you file a Chapter 7 case whenever you merely QUALIFY to do so. Your goal is not necessarily the simplest bankruptcy. Your goal is a better financial life, and using the right legal means to get there.

The above rule of thumb acknowledges two big truths about Chapter 7 and Chapter 13:

1. Chapter 7 is usually much simpler than Chapter 13—faster and cheaper.

2. Chapter 13 comes with a long list of potentially very helpful tools which are unavailable under Chapter 7.

 

Here are two contrary examples to illustrate this.

A husband and wife own a home they want to keep. They have fallen behind on the mortgage by three $1,500 payments, totaling $4,500, because of a few months of unemployment for one of them. Now that they are both employed, they believe that if they filed a Chapter 7 case to discharge all their other debts, they could put all their effort into paying off that $4,500 mortgage arrearage by paying $500 extra each month until they were caught up. It would be a struggle, but they are willing to do what it would take for the 9 months or so to accomplish that. And they are willing to take the risk that their mortgage lender might not accept those terms and the risk whether they would actually be able to consistently pay that string of monthly arrearage payments.

Chapter 7 seems like a sensible, if a bit risky, option here.

Now take the same situation with two twists. First, instead they are 6 months–$9,000—behind on the first mortgage. Second, they have a second mortgage of $30,000, and they owe more on their home’s first mortgage than the home is worth. Assuming that, as above, they could only afford about $500 per month towards the mortgage arrearage catch-up payments, it’s much less likely that their lender would allow them the now-18 months to bring the mortgage current after filing Chapter 7. However, Chapter 13 would allow them to stretch out these catch-up payments over a period of three to five years, reducing the monthly payment to a much lower and more sustainable amount. Plus, throughout this time they would be under the protection of the bankruptcy court, and could likely even change their payments if their circumstances changed. Furthermore, under Chapter 13 but not Chapter 7, they would likely be able to “strip” the second lien off the home’s title, meaning that they would likely avoid paying all or most of that $30,000 balance (together with many thousands of dollars of future interest).

In this second situation, Chapter 13 makes a lot more sense, likely costing less and being less risky.

Back to the rule of thumb: in the second example, Chapter 13 provided some tools—stretching out the arrearage payments and “stripping” the second mortgage–that would hugely help this couple save their home while saving money. In the first example, those tools either were not needed or didn’t apply, so Chapter 7 was the appropriate solution. 

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