Understanding Bankruptcy
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Chapter 11 vs. Chapter 7 Bankruptcy: What to Know

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If you’ve found yourself drowning in large amounts of debt, you’re surely overwhelmed about how to get out of it. Bankruptcy is a federal legal protection that is in place to help individuals or businesses who can’t pay back their debts.

We’ll explain and compare the pros and cons of two of the most common types — Chapter 11 and Chapter 7 bankruptcy — in an effort to help you determine if one of these may be the most appropriate step for your financial situation.

What is Chapter 11 bankruptcy?

Chapter 11 bankruptcy is a form of bankruptcy that allows businesses and corporations to rehabilitate or reorganize their processes so that they can continue to operate while repaying their debt.

Most people who file for Chapter 11 bankruptcy do so because their debt is well over the allowable limit to apply for Chapter 13 bankruptcy. While it’s usually reserved for large companies, occasionally individuals like small business owners or real estate investors will need to consider filing for Chapter 11 bankruptcy.

Through Chapter 11 bankruptcy, businesses can possibly adjust the terms on their existing debts, such as interest rates and payment amounts. Any loans with unaltered terms are required to be paid within five years of filing for bankruptcy.

After you’ve initially filed for Chapter 11 bankruptcy, you’ll need to propose a modified plan to repay your creditors. At least half of your creditors who own at least two-thirds of your debt must accept the plan, or allow you to modify it until you reach an agreement. Once your plan has been accepted, you’ll make your payments for up to five years.

ProsCons

  You can adjust your loan terms to be more manageable, and after five years, you’ll be fully discharged from loans with terms that haven't been modified

  The bankruptcy shouldn’t affect your personal credit score

  You have control to liquidate or sell some of your business assets to repay your creditors

  The process can take a long time (typically five years)

  The bankruptcy stays on your credit report for 10 years

  You could end up having to wait up to four years after discharging your bankruptcy to get a new mortgage

What is Chapter 7 bankruptcy?

Chapter 7 bankruptcy is often referred to as straight or liquidation bankruptcy. It’s available for individuals and businesses, although it’s most common among individuals.

People who file for Chapter 7 bankruptcy typically earn lower incomes and can’t repay their debts. To qualify for Chapter 7 bankruptcy, you must be earning less than your state’s median income for a family or household of your size.

You may have to sell some of your assets to pay off your debt. This only includes assets that are not exempt (examples of exempt property include cars, work-related equipment and furniture from your home). This type of bankruptcy may help you get rid of unsecured debt as well as stop situations such as foreclosures, repossessions, utility shut-offs and debt collection activities.

In nearly all cases, you will be discharged of all your outstanding debt after a Chapter 7 bankruptcy, allowing you to start fresh and rebuild your credit and savings. But it’s important to understand that this type of consumer bankruptcy won’t clear you of certain responsibilities such as child support, taxes, alimony and certain student loan requirements.

ProsCons

  You'll be relieved of all debts (because you need to sell your assets to repay your creditors)

  There's no maximum debt limit

  You must sell your assets and take a credit counseling course

  You must have low income and minimal assets to qualify

  The bankruptcy stays on your credit report for up to 10 years

What about Chapter 13 bankruptcy?

A third type of bankruptcy is Chapter 13 bankruptcy. This option — for individuals or sole proprietors — is different in that it allows you to create a repayment plan based on your anticipated income. In many cases, you’ll pay off most of your debt with monthly payments over the course of three to five years, after which time the rest of your debt is discharged.

An advantage of Chapter 13 bankruptcy is that it allows you to retain your assets, such as your house or car. Most individuals or one-person businesses qualify for Chapter 13 bankruptcy. A common use for it is to save a home from foreclosure. As of 2022, you can qualify if you have less than $465,275 in unsecured debt (like credit cards or personal loans) and $1,395,875 in secured debt (like a car loan or mortgage).

If you’ve been discharged from Chapter 13 or another type of bankruptcy within the last two to four years, you may not qualify to file.

How to avoid bankruptcy

While filing for bankruptcy can certainly bring relief to certain cases of extreme debt, it should remain a last resort. You’ll want to do everything possible to avoid filing for bankruptcy. Here are some alternative options:

  Work with your creditors: Consider picking up the phone and calling your credit card company to try to negotiate on a solution. It’s possible they will be willing to work with you to settle on a lower interest rate, lower your monthly payment or even reduce your balance.
  Consolidate debt: Consider a personal loan to consolidate your debt into one balance. This can help you save on interest and pay back your debt without having to give anything up as collateral.
  Cut expenses: Whether it’s giving up cable, limiting the number of nights you eat out every week or swapping a pricey gym membership for a more affordable option, there are ways you can cut down on your monthly expenses.
  Find a side hustle: From tutoring to dog walking or even driving for Uber, there are a number of side gig options to choose from these days.

 

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