If you find yourself in a mountain of debt that you just cannot dig yourself out of, you might consider filing for bankruptcy. Before you make this decision however, there are some important things you need to understand. The main thing to say is that life after bankruptcy is not easy. You will find it hard to get credit such as credit cards and if you are successful, chances are that you will be faced with an interest rate that is sky high.
For this reason, and the fact that you have to face the stigma of being bankrupt, bankruptcy should be a last resort. You should start by trying to come to an arrangement to pay creditors and getting some help with managing your finances. If you do decide that bankruptcy is the best option, you then need to take a look at the different types of bankruptcies, and decide which one is the best option for you. Although, the bankruptcy court will make the final decision.
Differences Between Chapter 7 and Chapter 11 Bankruptcy
You may not realize it, but there are some big differences between the different types of bankruptcy. Some require the sale of assets to pay creditors, others do not. In short, there are four types of bankruptcy.
- Chapter 7 – Liquidation of assets.
- Chapter 11 – Reorganization of assets.
- Chapter 12 – Adjustment of debts specifically for family farmers and fishermen.
- Chapter 13 – Adjustment of debts for an individual or small business.
In order to decide which is the best type of bankruptcy for you, it's important to understand the different types in more detail. I'm going to look at three of the four types of bankruptcy, Chapter 7, Chapter 11 and Chapter 13. The differences between Chapter 7 and Chapter 11 bankruptcy are very similar to the differences between Chapter 7 bankruptcy and Chapter 13 bankruptcy.
What Is Chapter 7 Bankruptcy?
Chapter 7 bankruptcy is often known as 'straight' bankruptcy. It's the most common form of bankruptcy chosen and the easiest to complete. To qualify for Chapter 7 bankruptcy, you need to have a monthly income that is less than the median income for the state where you live, based on the size of your household, or you must complete a means test.
If you qualify for this type of bankruptcy, any assets that are not exempt are sold to pay off unsecured debts owed to unsecured creditors. Payments for secured debts, to secured creditors, continue. Once the sale of assets to pay off unsecured debt is complete, any debt that remains is usually discharged.
This does not apply to certain debt including child support, alimony and some taxes. It does not usually apply to student loans, unless you can prove severe financial hardship under The Brunner Test.
The rules about assets that are exempt from sale varies from state to to state. These rules state how much value in assets someone who has filed for chapter 7 bankruptcy can keep. For instance, if someone has a car that is worth $2,000 and the exemption amount is $5,000, the car will not be sold. Chapter 7 bankruptcy is a means of an individual, couple or business escaping from under a pile of unsecured debt. However, it does mean that several valuable assets can be sold and should be treated as a last resort. For anyone who does not qualify for Chapter 7 bankruptcy, or wants to avoid the sale of assets, there are other options.
What is Chapter 13 bankruptcy?
I did not refer to Chapter 13 bankruptcy in the title of this article as it's very similar to Chapter 11 bankruptcy. According to the bankruptcy code, when you attend a bankruptcy court in respect of Chapter 13 bankruptcy, debts are not discharged immediately. This often happens when people do not qualify for Chapter 7 bankruptcy.
Instead of debts being discharged at the start, a repayment plan is set up, so that debt can be repaid over a period of 3-5 years. Debt that remains at the end of this time can then often be discharged. If you are unable to make the required payments at the current value of the assets, you may be able to request a cramdown provision. This means that the value of the assets is reduced to a fair market price and the payments are also reduced.
In order to be accepted for Chapter 13 bankruptcy, you need to be realistically able to pay off all or most of your unsecured debt within 3-5 years. If this is not possible because of the size of the debt, you may need to be considered for Chapter 11 bankruptcy.
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What is Chapter 11 bankruptcy?
Because of the size of the debt involved, Chapter 11 bankruptcy is commonly applied to businesses. However, just like Chapter 7 and Chapter 13 bankruptcy, it can be applied to individuals and couples as well.
The main difference between Chapter 7 bankruptcy and Chapter 11 bankruptcy is that debts are not discharged. Instead repayments are re-organized. Because the debt involved tends to be high, creditors are extremely concerned about getting a good portion of their money back. Since they are all fighting for the most money, the process of bankruptcy can get ugly and drawn out. When this happens, the fees paid to a bankruptcy attorney can be very high.
The different types of bankruptcy – in summary
Bankruptcy can be a complicated process, so you need to speak to a bankruptcy attorney to get a full range of advice. However, here are the basic differences between the different types of bankruptcy in summary.
|Chapter 7 bankruptcy||Chapter 11 bankruptcy||Chapter 13 bankruptcy|
|Liquidation bankruptcy||Re-organization bankruptcy||Re-organization bankruptcy|
|Can be applied to individuals, couples or businesses.||Can be applied to individuals, couples or businesses.||Can be applied to individuals, couples or businesses.|
|Suitable when there is no money available to pay unsecured debts and qualifying conditions are met.||Suitable when there are sufficient resources to be able to make payments for unsecured debt, over 3-5 years, according to a repayment plan.||Suitable when debt is so high that a 3-5 year repayment plan is not an option.|
|Some assets are sold and any remaining debt is discharged (with some exceptions).||Assets are retained and debt is only discharged, on some occasions, after 3-5 years.||Assets are retained. Debt is not discharged.|
Which type of bankruptcy should you choose?
The best thing to do is to try and avoid bankruptcy altogether. It should only ever be a final solution. If bankruptcy does seem the only way to go, Chapter 13 can be the best option for many people, as assets are retained and the process is less long and messy than Chapter 11 bankruptcy. At the end of the day, you can decide which type of bankruptcy you would prefer, but the bankruptcy court decides which type of bankruptcy you qualify for.