When most people think about bankruptcy, they are likely thinking about Chapter 7 bankruptcy. This is known as liquidation bankruptcy because it requires a person to liquidate any non-exempt assets. There are key exemptions, such as for the tools of the trade or the homestead exemption, but additional assets may need to be liquidated and the proceeds can be used to pay back creditors, prior to forgiving the rest of the debts.
This is not the only way that bankruptcy works, however. Another option is Chapter 13 bankruptcy, known as reorganization bankruptcy. How is this different and what benefits may it have?
Reorganizing existing debt
One key difference is that liquidation is typically not required. People are able to keep all of their assets.
Another difference is that someone has to pass a means test, looking at their assets and income, to qualify for Chapter 7 bankruptcy. But if they do not qualify because they cannot pass the means test – such as if they have a high income – then they may still qualify for Chapter 13.
This is because the biggest difference is simply that Chapter 13 consolidates debt into a repayment plan, which will be used for the next three to five years. The person is required to make monthly payments into this plan, gradually taking care of their debt over time, rather than liquidating assets and forgiving the debt up front.
Depending on your financial situation, one type of bankruptcy could be better for you than the other, so it is crucial that you understand how they both work and what it takes to qualify.