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Factors to Consider when Filing for Bankruptcy

To many people, the decision to declare bankruptcy is a very difficult one. There are the
short term and long term implications of such declaration that one needs to consider. Then there
is also the stigma that surrounds bankruptcy declarations. Even though it has been waning over
the years, it is still potent enough to induce reluctance to declare bankruptcy. Whatever
reservations one may have, however, once they decide to declare bankruptcy it is important to
carefully evaluate their choices. Here is a look at bankruptcy options available and some of the
factors to consider when evaluating them.

Personal bankruptcy options

There are two main personal bankruptcy options. These are Chapter 7 and Chapter 13.
Even though individuals can also use Chapter 11 option, it is mainly used by business entities
such as corporations. When a debtor opts for Chapter 7, their properties are placed under control
of a trustee. The trustee’s role is to sell the assets and use proceeds of the liquidation to repay
creditors. Not all assets, however, can be liquidated under Chapter 7. The type of exempt
properties vary from state to state but generally include cash not exceeding $20,000 and family
car (Elias & O’Neill, 2015). It is also worth noting that Chapter 7 does not cover all debts. Some
types of debts that are not covered under Chapter 7 include child or spousal support, fines for
debtor’s crimes, property tax, student loans, and income tax debt that is less than three years
(Elias & O’Neill, 2015).

Unlike Chapter 7, Chapter 13 does not require the debtor to liquidate their assets to repay
creditors. Instead, the option allows them to reorganize their finances, consolidate their debts and

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repay creditors within a span of three to five years (Eraslan et al., 2017). The repayment follows
a payment plan approved by a bankruptcy court. This option is suitable for debtors who have
regular income and, therefore, can repay their debts within the agreed period.

Factors to consider when evaluating bankruptcy options

Eligibility

Before choosing between the two options, it is important to determine the type of
bankruptcy that the debtor is eligible for. Chapter 7 requires that the debtor’s income in the
previous six months be less than the median income of the state that they reside in (Elias &
O’Neill, 2015). They should also have disposable income that is above a certain figure. For
Chapter 13, the debtor must have enough disposable income to make regular payments under
terms agreed upon in the payment plan (Eraslan et al., 2017). Thus, a debtor can only qualify for
Chapter 13 if they have regular income and enough disposable income to make the regular
payments.

Cost

Cost is a major consideration when filing for bankruptcy. By the time a debtor decides to
file for bankruptcy they are usually in a difficult financial position. It is, therefore, important that
they minimise the amount of money that they spend in filing for bankruptcy. Some of the fees
that make bankruptcy filing a relatively expensive undertaking include administrative, filing,
court, and legal fees (Eraslan et al., 2017). Of these, legal fees takes the largest portion. Since
most lawyers’ fees depends on the complexity of the process and, therefore, the amount of time
that they are going to spend on it, drawn out bankruptcy cases cost more. Of the two options,

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Chapter 7 is generally cheaper than Chapter 13. Unlike Chapter 7, Chapter 13 process takes
between three to five years. During that time, the debtor has to pay all the expenses related to the
case. Thus, if a debtor is eligible for both options, choosing Chapter 7 is the cheaper option.

Asset protection

The main difference between the two options is that in Chapter 13 the debtor keeps their
assets while in Chapter 7 all their assets, except for the exempt ones, are liquidated. Thus, if a
debtor has assets that they do not want to lose they may consider going for Chapter 13. This
explains why Chapter 13 is particularly popular with debtors facing foreclosures.

Effect on credit worthiness

Whether you declare bankruptcy under Chapter 7 or Chapter 13, your credit report will
indicate that you have a bankruptcy. For Chapter 7, it shows for 10 years while for Chapter the
duration is 7 years (Eraslan et al., 2017). In this regard, it may seem that Chapter 13 is the better
option. This is, however, not the case. For new creditors, their main concern is whether you have
been discharged from the bankruptcy. In other words, whether the bankruptcy case is over. Once
you are discharged you can start borrowing again. For debtors filing bankruptcy under Chapter 7,
the discharge often occurs after a few months of filing (Elias & O’Neill, 2015). However, for
applicants under Chapter 13 it may take as many as 5 years for the debtor to be discharged. Thus,
filing for bankruptcy under Chapter 7 allows the debtor to resume borrowing sooner than filing
under Chapter 13.

When it comes to filing for personal bankruptcy, the decision on whether to file under
Chapter 7 or Chapter 13 depends on the circumstances and objectives of the debtor. Generally, if

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the debtor has an irregular and average income, or no income at all the best option is Chapter 7.
Chapter 13 is suitable for persons with regular income and important assets to protect from
liquidation or foreclosures.

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References

Elias, S., & O’Neill, C. (2015). How to file for Chapter 7 Bankruptcy. Nolo.

Eraslan, H., Koşar, G., Li, W., & Sarte, P. D. (2017). An anatomy of US personal bankruptcy under
Chapter 13. International Economic Review, 58(3), 671-702.