Chapter 7 bankruptcy is a liquidation bankruptcy. A person has overwhelming debt, but they still own specific assets. They are required to liquidate nonexempt assets—there are often key exemptions for things like tools of the trade, residential property or vehicles—and then creditors are paid back based on the money generated during this liquidation. Remaining debt is then canceled.
However, someone has to pass a means test just to qualify for Chapter 7 bankruptcy in the first place. If a person has a relatively high level of income, they are not going to pass this test and they will not be eligible. Does this mean they cannot file for bankruptcy at all and have to handle their debt on their own?
Utilizing Chapter 13 bankruptcy
Not necessarily. It just changes the type of bankruptcy that they can use. Instead of Chapter 7, they may need to use Chapter 13.
Chapter 13 bankruptcy is designed for wage earners. Instead of requiring liquidation, it consolidates debt into a repayment plan. This is based on the person’s monthly income, with the goal of creating one affordable monthly payment that they can make for the next three to five years.
By doing this, the debtor spreads those financial obligations out over a longer timeframe. Because they still have a steady income, the payments are affordable, and spreading the debt out makes it so that they can address it gradually. This type of bankruptcy can still give them more financial freedom and relief, and they do not have to liquidate any of their assets.
Which chapter is right for you?
There are pros and cons to both types of bankruptcy. To determine which type you are eligible for and which will apply in your situation, it can help to work with an experienced attorney.