People choose to file Chapter 13 over Chapter 7 in order to hold onto certain assets, says Madden. When your trustee files under Chapter 7, you’re obligated to sell assets to pay off debts, with the exception of a protected amount that varies by state. For example, in North Carolina, you can protect $35,000 in home equity, but if your house is worth more than that, you must sell the property and use all but $35,000 of the proceeds to pay off debts.
Should you decide to convert from a Chapter 13 to a Chapter 7 bankruptcy, the process varies depending on the bankruptcy court, says David Haynes, a California bankruptcy attorney. For example, courts require you to file a formal written request, but some may also require a hearing where you will appear before a bankruptcy judge.
Another option for those unable to complete a Chapter 13 repayment plan is to request a hardship discharge, which relieves the filer of the rest of his or her obligations. However, a Chapter 13 hardship discharge is rarely granted, says Madden. To qualify, a debtor must prove that he or she cannot make the payments under no fault of their own but because of extreme circumstances, such as severe illness. Creditors must have received as much as they would have gained through a Chapter 7 bankruptcy, and a Chapter 13 modification must be shown to be impossible. The filer would likely lose any property covered under the repayment plan.
When it comes to credit implications, regardless of the chapter filed, a bankruptcy can lead to a 250-plus point FICO score drop for someone whose score previously was in the high 700s, says John Ulzheimer, president of consumer education for SmartCredit.com. The main difference is the amount of time the bankruptcy stays on your credit report, he adds. A Chapter 7 bankruptcy remains on your credit report for 10 years from the filing date while a Chapter 13 bankruptcy stays on for seven years from the discharge date. So, if you complete your Chapter 13 plan in five years, it would still remain on your credit report for 12 years. However, when you convert from a Chapter 13 to a Chapter 7, the countdown to the day that the bankruptcy drops off your credit report starts over with the filing date, Ulzheimer says.
For many, the credit hit is outweighed by the lure of a second chance. “Converting to Chapter 7 was a huge relief,†says Kershaw.