Why I Prefer Chapter 7 Bankruptcy to Chapter 13 Debt Consolidation
Most folks considering bankruptcy will consider two options – Chapter 7 and Chapter 13. Sometimes, you have the option of choosing either type of bankruptcy, whereas in other situations you would only be eligible to file either a Chapter 7 or a Chapter 13.
When I meet with a client, I always start with the question of how can I fit this person into Chapter 7. It is not always possible, but, in my experience my Chapter 7 just works better – my clients get their discharge that wipes out debt completely, their cases are over in about 5 months, credit rebuilding can start within a year and the cost of bankruptcy is about 25% of the cost of Chapter 13.
Now, Chapter 13 may be the only realistic option:
if you are facing a mortgage foreclosure and you want to keep your house;
if you are facing a vehicle repossession and you want to keep your car/truck;
if your household earnings put you well over the median income for your family size;
if you own significant assets free and clear; or
if you truly need to restructure your debts.
But before you start the process, keep in mind some of the significant negatives associated with Chapter 13:
you will be in bankruptcy for a long time – 5 years in most cases. This means that for the next 5 years, you will have a partner in the form of your Chapter 13 trustee who will have to approve any significant financial move.
Need to finance a new roof or a major car repair – you will first have to get approval from the trustee.
Have a family emergency and need to skip a trustee payment – the trustee will have to approve.
Changing jobs and have a new salary – your trustee will expect a new budget.
and if you are making less money and want to reduce your trustee payment, you could face objections and a possible motion to dismiss from the trustee and creditors.
most Chapter 13 cases don’t work – about 2/3 of all Chapter 13 cases will end up dismissed before completion and discharge. Many Chapter 13 trustees take a very aggressive approach to household budgeting. You will need to account for every dollar you spend. Most Chapter 13 trustees will object to any budget that contains an emergency fund or Christmas account – they will tell you to come to court and ask the judge for relief if you have an emergency. Can you imagine not having unexpected financial emergencies over the next 5 years? That is the unstated assumption in Chapter 13.
Chapter 13 cases are expensive – most attorneys charge between $3,500 and $5,000 for a Chapter 13 case – because they last 5 years and are a lot of work. By contrast, Chapter 7 will cost you between $1,000 and $2,000 in most areas.
Chapter 13 often does not solve the underlying problem that led you into bankruptcy. Are you trying to hang on to a home or car that you really cannot afford? Is your income really steady enough to support a regular payment over the next 5 years. The truth is that middle income wage earners in the United States often change jobs frequently and often involuntarily. Those gaps in income may very well end your hopes at a Chapter 13 discharge. And if your case is dismissed before completion and discharge, all your creditors will come roaring back and any progress you may have made paying down your debt will likely be wiped out by penalties and interest charges.
I could go on, but you most likely get the idea – Chapter 13 is an expensive option that often doesn’t work and it is based on an unrealistic expectation that you will have stable household income over the next 5 years.
In my view, the Chapter 13 laws need a re-do to reflect the realities of economic realities in the United States today. What this re-do might look like is a topic for another day but after almost 30 years of representing honest, hardworking debtors in Atlanta, I see Chapter 13 not so much as a realistic solution for most people, but a last gasp effort to delay the inevitable.
So what does this mean to you if your attorney tells you that you don’t fit into Chapter 7?
Step one is to find out why. If the problem is your over median income then you can’t do much about that. However, if the need for Chapter 13 is based on your ownership of non-exempt property, or because you are trying to save a house or car, I would suggest that you consider going into a Chapter 7 and surrendering your property (house, car, jewelry, furniture, appliances) back to the lender. Your household budget will no longer be stretched to the breaking point and you can truly “start over.”
Ironically, you may be able to negotiate a significant discount for some big ticket secured collateral. I have worked out deals in Chapter 7 to allow my clients to keep appliances, jewelry, furniture, cars and houses. Lenders are going to incur costs collecting, storing, processing and selling secured collateral and you may be able to work out a very favorable price.
If you absolutely have to file Chapter 13 to save your house or even your car, don’t hesitate to ask your lawyer to run the numbers on a plan that surrenders other secured collateral – anything you can do to make your plan workable over 5 years is a plus.
Far too often, I see Chapter 13 debtors lose everything because they are unwilling to give up anything. Make bankruptcy work for you and not the other way around.