Most people considering bankruptcy have 2 options – Chapter 7 and Chapter 13. Chapter 7 bankruptcy (also known as straight bankruptcy) helps you discharge debts through asset liquidation. On the other hand, Chapter 13 bankruptcy (also known as reorganization bankruptcy) discharges your debts through a customized repayment plan. Both have pros and cons. But if I ever file bankruptcy, I would always opt for Chapter 7 bankruptcy instead of Chapter 13, and there are valid reasons behind my preference. Here are a few of them.
- Chapter 13 bankruptcy is a long-term plan: You’ll be in bankruptcy for 5 years. It’s a long time. You can’t make any financial decision without the approval of the bankruptcy trustee. If you’re switching jobs, your trustee will ask you to create a new budget. If you want to repair your car, you have to get approval from the trustee. If your monthly income drops due to any reason, you could face lots of objections from creditors and the trustee. It’s like being in a jail. You can’t do anything independently.
- Chapter 13 has no provision for an emergency fund: You can’t allocate any money to an emergency fund in Chapter 13. Yes. Most bankruptcy trustees won’t allow you to create an emergency fund. You have to include every penny of your disposable income into your repayment plan. This implies that you have to always hope that there is no emergency situation in the next 60 months. But it’s an unrealistic hope. Don’t you think so?
- Chapter 13 is quite expensive: As I have already said, Chapter 13 lasts for 5 years and is a lot of hard work. Bankruptcy attorneys charge between $3500 and $5000 because they have to work for 5 years. Chapter 7 bankruptcy lasts for 4 months and is cheaper than Chapter 13 bankruptcy. The attorneys charge between $1000 and $2000 in most states.
- Chapter 13 has 65% failure rate: Most Chapter 13 bankruptcy repayment plans fail mainly due to unrealistic budgeting. There is no place for an emergency fund. You have to report every dollar you spend. The trustee also takes a very aggressive approach. Can you live like this for 5 years? Just think rationally. Is it possible to rush to court whenever you have a financial emergency? It isn’t possible.
Why Chapter 13 bankruptcy doesn’t work
Usually, Chapter 13 bankruptcy fails due to the following reasons:
- Sudden job loss or change
- Sudden health issues
- Family emergencies
- Unexpected car repair needs
- Debtors don’t understand their obligations properly
- Chapter 13 bankruptcy attorneys are not experienced
The biggest reason why Chapter 13 fails is because it doesn’t solve the problem that led you to bankruptcy. You have to make regular payments to the bankruptcy trustee for 5 years. This means you need to have a stable income for the next 60 months. The reality is something different.
Middle-class Americans change jobs frequently and often unwillingly. Those gaps in income can lead to Chapter 13 bankruptcy dismissal. If your bankruptcy case is dismissed before discharge, creditors will haunt you and any progress you have made will be eliminated by penalties and interest charges.
Why Chapter 7 bankruptcy works
Chapter 7 bankruptcy eliminates your debts completely, and that too in just 3-4 months. You can start rebuilding your credit within a year. Moreover, the cost of Chapter 7 bankruptcy is only 25% of the cost of reorganization bankruptcy. If you want to opt for reorganization bankruptcy just for the sake of saving your house or vehicle, then I would ask you to file straight bankruptcy. Surrender your assets to the lender. At least, your household budget won’t be stretched to the breaking point for the next 60 months. You can make a fresh financial start after 4 months.
You can also get a discount for some big-ticket collaterals. If you’re lucky, you can keep jewelry, cars, appliances, etc. in Chapter 7 bankruptcy. Lenders have to spend a significant amount for collecting, processing, storing, and selling secured assets, and you may be able to get a good deal.