Understanding the differences between Chapter 7 and Chapter 13 bankruptcy is crucial when considering filing for bankruptcy. Each type has distinct processes, eligibility requirements, and outcomes, and choosing the right one depends on your financial situation and goals. This blog post will delve into the key differences between Chapter 7 and Chapter 13 bankruptcy, including a thorough explanation of the means test used for Chapter 7 eligibility.
Chapter 7 Bankruptcy: Liquidation
Chapter 7 bankruptcy, also known as “liquidation bankruptcy,” is designed for individuals who cannot repay their debts. Here’s how it works:
- Eligibility: To qualify for Chapter 7, you must pass the means test (more on that below). This type of bankruptcy is typically suitable for those with low income and few assets.
- Process: Upon filing, a bankruptcy trustee is appointed to review your case. The trustee will liquidate (sell) your non-exempt assets to repay creditors. Certain essential assets may be exempt from liquidation.
- Outcome: Most of your unsecured debts, such as credit card debt, medical bills, and personal loans, are discharged, meaning you are no longer legally required to pay them.
- Timeline: Chapter 7 bankruptcy usually takes about 3-6 months to complete.
Chapter 13 Bankruptcy: Reorganization
Chapter 13 bankruptcy, known as “reorganization bankruptcy,” is ideal for individuals with a regular income who wish to keep their assets and repay their debts over time. Here’s a breakdown:
- Eligibility: You must have a regular income and your secured and unsecured debts must be below certain limits set by the bankruptcy code.
- Process: You will propose a repayment plan to the court, detailing how you will pay off your debts over 3-5 years. The bankruptcy trustee oversees your payments and distributes them to creditors.
- Outcome: At the end of the repayment period, any remaining unsecured debts may be discharged.
- Timeline: The repayment plan lasts between 3-5 years, depending on your income and the amount of debt.
The Means Test Explained
The means test is a critical component in determining eligibility for Chapter 7 bankruptcy. It aims to prevent individuals with higher incomes from filing for Chapter 7 when they can afford to repay their debts through Chapter 13. Here’s how the means test works:
- Step 1: Calculate Your Current Monthly Income (CMI): Your CMI is your average monthly income over the six months before filing for bankruptcy. This includes wages, salary, tips, bonuses, unemployment benefits, and other income sources.
- Step 2: Compare CMI to Median Income: Compare your CMI to the median income for a household of your size in your state. If your CMI is below the median, you qualify for Chapter 7. If it’s above, proceed to the next step.
- Step 3: Calculate Disposable Income: Subtract allowable expenses from your CMI to determine your disposable income. Allowable expenses include costs for housing, utilities, food, transportation, medical care, and other necessities, based on IRS standards.
- Step 4: Determine Eligibility: If your disposable income is below a certain threshold, you pass the means test and qualify for Chapter 7. If it’s above the threshold, you may need to file for Chapter 13 instead.
Understanding the differences between Chapter 7 and Chapter 13 bankruptcy, along with the means test, can help you make an informed decision about your financial future. Consulting with a knowledgeable bankruptcy attorney can provide personalized guidance and ensure you navigate the bankruptcy process effectively.
