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How does Chapter 13 differ from Chapter 7?

For people struggling with extreme levels of debt, one of the best and most effective forms of relief can be filing for bankruptcy. Deciding to take advantage of bankruptcy protection is only the first step, however, because there are various different types of bankruptcy under which a person can file. "Debt reorganization," or Chapter 13 bankruptcy, differs from Chapter 7 bankruptcy, commonly known as liquidation bankruptcy, in several important ways.

First of all, there are different eligibility requirements for Chapter 13 bankruptcy because this form of bankruptcy is intended for people who have a regular income and are able to create a payment plan to satisfy some of their debt obligations. In order to qualify for Chapter 13, a person does not have to pass the "means test" required by Chapter 7, and income is not an eligibility factor. Chapter 7, however, is going to generally require that the filer have an income less than that which is the median in the state in which the filer lives.

Chapter 13 bankruptcy also operates differently than Chapter 7. With a Chapter 13 filing, a person will file a petition for bankruptcy along with a proposed plan to eliminate his or her debt with the court only after undergoing mandatory credit counseling. In general, the payment plan describes how a filer will make payments on his or her debt obligations over a period of three to five years. The filer will be able to retain his or her assets-they are not required to be sold to pay off debt-and the payments on debt will come from the filer's disposable income. In contrast, Chapter 7 generally requires the surrender of any assets that are not exempt from the law, which are used to raise funds with which creditors are paid.

Debts are also dealt with differently under the two forms of bankruptcy. After filing a petition under Chapter 7, and after the asset sale and creditor payment phase outlined above, the majority of outstanding creditors remaining will not be able to recoup their money, as the debt will be discharged. With Chapter 13, however, a debtor will pay off all or a significant portion of debt under the payment plan.

Source: American Bar Association, "General Comparison of Chapter 7 and Chapter 13 Bankruptcy," last accessed Jan. 21, 2015

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