The Chapter 7 vs. Chapter 13 Question

You never thought you'd be in this position, but you're so far in debt you're considering bankruptcy. You have nearly $80,000 in medical bills and another $20,000 in credit card debt from being out of work for months after an injury. Now you've lost your job, and have fallen behind on your mortgage. The hospital and the credit card agencies are threatening to sue you, and if they win judgments against you, you could be forced to sell your home to pay the bills. Your credit rating has plunged, threatening your ability to get any financing or loans in the future. Could bankruptcy help solve your problems? And if so, which kind of bankruptcy do you need?

Bankruptcy is a legitimate legal process that allows people or businesses in financial trouble to erase or repay most debts and start over. It can help prevent creditors from harassing you, garnishing your wages or foreclosing on your home. But there can be a lot of shame and stress connected with filing for bankruptcy, and you may fear that it will ruin your credit forever.

"It's one of the hardest things people can do," says Ed Boltz, a Raleigh NC-based bankruptcy attorney and president of the National Association of Consumer Bankruptcy Attorneys (NACBA). "But if you file sooner rather than later, it's better for your credit in the long run." He adds that people who wait until they are facing lawsuits to file for bankruptcy often have an especially difficult time getting their finances back on track.

This guide looks at the two most common bankruptcy plans for individuals, known as Chapter 7 and Chapter 13. Both can halt debt collection and give you a new financial start. We'll explore the basics of each option and offer some insider tips. To choose the option that's better for you, you'll need to talk with a bankruptcy attorney, since our guide is not a substitute for legal advice.

Chapter 7 involves liquidating your assets to eliminate debt - that is, selling the assets you have. This kind of bankruptcy eliminates unsecured debts, such as medical bills, credit cards, store cards, utility bills, payday loans and other debt that are not backed by property (collateral). It is called "liquidation" because all or some of your property may be sold (liquidated) to pay off some of your debt.

It is usually used when:

• You don't own a house or have a lot of possessions, except for basics like clothing and furniture;
• After you pay your rent and basic monthly expenses, you don't have enough left to pay down your debts
• You owe mostly unsecured debt - that is, debt that isn't tied to collateral such as your house or car. These debts may include medical bills and credit card and store card bills.

• Your income is equal to or less than the median income for a family of your size in your state.
• Even if your income is higher than that, you can qualify by passing a "means test." You can pass this test if you have a lot of expenses, such as high mortgage, car loan payments and taxes that eat up your income. The Census Bureau has a state-by-state online means list. However, the means test can become complicated, so it's best to check with an attorney.
• You are a disabled veteran whose debts were incurred during active duty.
• Your debts come primarily from the operation of a business.
• You complete required credit counseling from a government-approved organization within 180 days before you file. You also have to complete a debtor education course before your debts can be discharged. Check the list of approved debtor education providers online or at the bankruptcy clerk's office in your district.
• You have not had a Chapter 7 bankruptcy in the last eight years.

• You can wipe out most unsecured debt. This is debt for which you have not pledged collateral. It means, for example, that most credit card and medical bills will be erased.
• Depending on state laws, you may get to keep essential property such as personal possession, clothes, household furnishings and your car. Social Security payments and the tools of your trade may also be exempt.
• This bankruptcy process can be completed in four to six months and is relatively cheap, costing about $335 in filing and administrative fees (not including attorney fees), and usually requires only one trip to the courthouse.
• While this is in process, an "automatic stay" immediately stops any lawsuits and most actions by creditors, collection agencies or government agencies. It stops your creditors from harassing you, taking any actions to collect money, evicting you, garnishing your wages or foreclosing your house. (But you will need to still be able to pay for your mortgage after bankruptcy).
• You can start rebuilding and be on your way to a fresh financial start in just a few months.

• Bankruptcy can stay on your credit report for up to 10 years.
• Your credit score - a three-digit number that shows how good a credit risk you are - will be lowered by up to 150 points or more. But you can start rebuilding it almost immediately. Also, keep in mind that carrying a lot of debt will lower your credit score too, perhaps as much as bankruptcy.
• It becomes public record. You are not obligated to volunteer this information to potential employers or creditors, but they can easily find out on their own.
• If you have a co-signer on any debts, the person is not protected by your bankruptcy, and creditors can go after them for repayment.
• You may have a harder time renting a new home or taking out anything other than a subprime loan for at least several years.

Chapter 13 is designed to halt foreclosure on a home or other secured property. It creates a payment plan so you can pay off your debts over the next 3 to 5 years. Since you need a steady income to do this, it is sometimes called a "wage earner's plan."

It is usually used when:

• You have significant investment (equity) in your house or other property and want to avoid losing it through foreclosure.
• You have a regular income and can pay basic living expenses but can't keep up with payment on all of your debts.
• You can make a plan to pay down your debts over 3 to 5 years.
• You are not eligible to file for Chapter 7 bankruptcy.

• Your unsecured debts (credit cards and medical bills, for example) total less than $394,725 and your secured debts (such as mortgages) are less than $1,184,200. You must be able to prove to the court that you can afford to meet your repayment obligations.
• You can complete required credit counseling from a government-approved organization within 180 days before you file. You also have to complete a debtor education course before your debts can be discharged. Check the list of approved debtor education providers online or at the bankruptcy clerk's office in your district.

• You can stop foreclosure and keep most of your property.
• You can get placed on an interest-free plan to repay mortgage and other debts at a reasonable rate over 3 to 5 years.
• You can make one monthly payment that will get distributed among your debtors.
• Debts that can't be discharged by Chapter 7 — such as taxes and bankruptcy on student loans — may be included in a Chapter 13 filing. (See Your Debts in Chapter 13 Bankruptcy.)
• While this is in process, an "automatic stay" immediately stops any lawsuits and most actions by creditors, collection agencies or government agencies. It stops your creditors from harassing you, taking any actions to collect what you owe, evicting you, garnishing your wages or foreclosing on your home.
• You won't be contacted by your creditors over that 3- to 5-year repayment period.
• Your co-signers - such as a relative - are protected from your debts.

• Chapter 13 is more complicated and may take longer to file and be approved. The repayment plan will last from 3 to 5 years.
• Bankruptcy can stay on your credit report for up to 10 years. However, the effect of bankruptcy on your credit may be about the same as it is in your current debt situation.
• Your credit score - a three digit number that shows how good a credit risk you are - will fall by up to 150 points or more. But you can start rebuilding it almost immediately.
• The bankruptcy becomes public record. You are not obligated to volunteer this information to potential employers or creditors, but they can easily find out on their own.
• You may have a harder time renting a new home or getting anything other than a subprime loan for several years.

You don't necessarily need to pay an attorney to file for bankruptcy, but it's generally a good idea.

"If your case is not complicated and you don't have a home or a lot of assets, you may be able to handle it without an attorney," says Cara O'Neil, an attorney and legal editor for Nolo Press, a publisher of legal guides for consumers.

"The problem is that there is potential for making an error, especially if you have assets you want to protect, such as your home," she says. "Once your case is filed, it stands. So if you don't completely understand the process and you make an error, you may end up forfeiting property you could have saved." If you do consult with a lawyer, it's best to find one who is well-versed in the complex laws of bankruptcy. "If you're going to see a lawyer, see a specialist. You're not going to pay any more," Boltz says. Many or most lawyers specializing in bankruptcy offer a first consult free, he added. You can find bankruptcy lawyers listed through your state's bar association, or on websites such as NACBA. Check out credentials, and don't be fooled by people who prepare forms and who say they are just as good as a lawyer. "All they are legally allowed to do is type," Boltz says. "They can't give you advice."

Filing fees are set by the courts, and are generally under $400. Costs for legal help vary. For Chapter 7, lawyers fees are generally under $2,000. For Chapter 13, they are between $3,500- $5,000. Some of the expenses may be tax deductible, so check with a tax expert.

If you can't afford a lawyer, you may qualify for free legal services. Try these resources:

• The American Bar Association
  The ABA may be able to connect with you with a pro bono attorney.

• Legal Services Corporation
  LSC is an independent nonprofit established by Congress in 1974 to provide financial support for civil legal aid to low-income Americans. The Corporation currently provides funding to 134 independent nonprofit legal aid organizations in every state, the District of Columbia, and U.S. Territories. You can find a service near you here.

You can also find more information about filing fees and attorney fees at the U.S. bankruptcy courts.

James Haller is president of the National Association of Consumer Bankruptcy Attorneys (NACBA). He is an attorney with the Sulaiman Law Group of Chicago and has written extensively about many aspects of bankruptcy.