Simple Debts under Chapter 7 and Chapter 13

Law Office of Robert L. Firth Jan. 25, 2016

Chapter 7 arguably deals with simple debts better than does Chapter 13. Are all or most of your debts simple ones?

A Helpful Rule of Thumb

The point of bankruptcy is to help with your debts. There are certainly other considerations that come into choosing between these two options. But the type of debts you have is often the most important consideration.

This leads to an overly simple but still helpful rule of thumb:

  • Chapter 7 “straight bankruptcy” handles your simple debts better than does Chapter 13.

  • Chapter 13 “adjustment of debts” handles your more complicated debts better than does Chapter 7.

Chapter 7 is generally a simpler kind of bankruptcy than Chapter 13. After all it’s usually finished within about three months instead 3 to 5 years. Chapter 7 essentially writes off most of your debts but doesn’t help with debts that you either want to keep (like for your home or car) or can’t write off (such as recent income taxes and unpaid child support). Chapter 13 provides longer term help with those special kinds of debts and keeps you and your assets protected from your creditors during the 3 to 5 years.

Today’s blog addresses the simple debts side of this. The next one addresses the more complicated debts side.

Simple Debts

For our purposes here today we are including among simple debts those that are “general unsecured.” Those are ones that neither have any collateral securing them nor are among the “priority” debts which the law treats as special. “General unsecured” debts include most credit cards, medical debts, personal loans with no collateral, utility bills, back rent, and many others.

Simple debts can also be secured ones—backed up by collateral like your home or vehicle. They are relatively simple if you are current on the debt and want to keep the collateral, or simply want to give the collateral to the creditor.

Simple Unsecured Debts in Chapter 7 and Chapter 13

Chapter 7 is usually the better way to deal with “general unsecured” debts because most of them are simply discharged (written off) forever in a quick procedure.

Chapter 13 instead usually requires you to pay a portion of these “general unsecured” debts. When you hear a Chapter 13 plan being referred to a “15% plan,” that means that the “general unsecured” debts are to be paid 15% of the amount owed on them.

Many courts allow “0% plans,” meaning that all the money being paid to creditors is going to secured or priority debts (plus trustee and attorney fees), leaving nothing for the “general unsecured” debts.

But even when a plan calls for 0% of these debts to be paid, that can change if your financial circumstances improve during the first three years after your Chapter 13 case is filed. In contrast, if your income increases a year or two after your Chapter 7 case is filed you would have no obligation to pay anything on the “general unsecured” debts that were discharged a year or two earlier.

Simple Secured Debts in Chapter 7 and Chapter 13

As for simple secured debts, Chapter 7 works fine if you are current on the payments, want to keep the collateral and maintain the regular payments. And if you are surrendering the collateral, Chapter 7 will almost always discharge any remaining debt, and do so quickly without the risk of having to pay any of it out of your future income.

Chapter 13 also deals well with simple secured debts where you want to keep the collateral and you’re current on the loan. But unless there are other reasons to file a Chapter 13 case, having such simple secured debts is usually not a valid reason to do so.

If you’re surrendering collateral to the creditor, any remaining debt after the surrender becomes “general unsecured” debt. It gets paid the same percentage as the rest of your “general unsecured” debts, instead of just being discharged in a Chapter 7 case.

This may not actually increase how much you are paying because often you pay ALL your “general unsecured” debts a certain amount based on what you can afford to pay. Having an extra debt from surrendered collateral just distributes the same amount of money over that one extra debt, simply reducing how much other “general unsecured” debts receive.

But sometimes having more “general unsecured” debt DOES increase how much you have to pay. That may happen years into your case if your income increases. It’s just much easier and less risky to deal with such debts in a quick Chapter 7 case.

The next blog: how not-so-simple debts are handled in Chapter 7 and in Chapter 13.