Converting Chapter 13 to Chapter 7

Choosing to declare personal bankruptcy can be among the most difficult decisions ever to confront an individual. Tougher still: Having to pick, under unmatched duress, which type of bankruptcy best suits the consumer’s situation.

Sometimes, for any number of reasons, distressed people choose poorly. This is particularly true for those who, having opted for Chapter 13 (“wage earner’s bankruptcy”) — discover in midstream they’d be better off in Chapter 7 (“straight” or “liquidation” bankruptcy).

Good news: Converting Chapter 13 bankruptcy into Chapter 7 isn’t just possible, it happens with regularity.

In Chapter 13, consumers with regular income and a desire to protect certain personal assets enter a structured payment plan designed to satisfy most of the consumer’s debt over a 3–5-year period. At the end of the designated period, balances covered by the plan but not fully repaid are dismissed.

Chapter 7 does not involve a repayment plan. Instead, the filer surrenders nonexempt assets (which vary from state to state) to the bankruptcy trustee who sells them and uses the proceeds to pay creditors. With some exceptions — including alimony, child support, certain taxes, and student loans — balances that remain after the payouts are canceled (discharged).

“The issues the debtor should consider are the long-term effects of conversion,” says Wilmington, Del.-based Ted Gavin, former chairman of the American Bankruptcy Institute and an attorney with more than 20 years of experience counseling distressed companies and stakeholders.

“Does the fresh start of Chapter 7 give you more than you’ll give up in assets? Do exemptions help you save assets you wanted to keep? … Is there really an advantage to paying all of your excess income to service debt for five years, as is required in Chapter 13?

“The goal is to cure financial distress, not move it down the road another year and end up in the same place.”

Voluntarily converting a Chapter 13 bankruptcy to Chapter 7 relies on a handful of factors, among them clearing eligibility hurdles that include a “means test” that reviews income and expenses; and whether you’ve previously filed for bankruptcy. If you qualify, you file a “notice of conversion” and pay the $25 conversion fee.

Pros and Cons of Converting Chapter 13 to Chapter 7

Personal bankruptcy offers two stark choices because one size cannot fit all consumers. This does not mean the circumstances that made someone a proper size for Chapter 13 cannot change so much that they become just right for Chapter 7.

But even if you’ve become eligible for a conversion, it’s wise to make certain Chapter 7 is a better fit.

Pros of Switching to Chapter 7

• Discharging most unsecured debts such as credit card balances and medical debt, which saves money.
• Reducing the amount of time spent in bankruptcy (about 4-6 months for Chapter 7 vs. up to five years for Chapter 13).
• Maintaining protection from debt collectors via automatic stay.
• Eliminating Chapter 13 payments.
• Automatic transfer of your forms and information from one filing to the next.

Cons of Switching to Chapter 7

• Nonexempt assets may have to be surrendered to the bankruptcy trustee. Those assets could include a home or a car.
• Some debts that can be wiped out in Chapter 13, including taxes charged on a credit card or a property-division debt owed to an ex-spouse, are immune to Chapter 7 relief.
• You might not qualify; there’s that means test we mentioned earlier.
• Creditors who hold non dischargeable debts, such as taxes and support obligations, and were held at bay by a Chapter 13 payment plan might resume collections actions, including wage garnishments and creditor lawsuits.
• There can be tax consequences. Penalties dischargeable under Chapter 13 might not be in a Chapter 7 conversion.
• A car loan that hasn’t been brought current under the Chapter 13 plan puts the vehicle at risk in Chapter 7.
• The bankruptcy process starts over; a new trustee is assigned, and you must attend a new meeting of creditors.
• Chapter 7 bankruptcies remain on your credit report for 10 years, three years longer than a successfully completed Chapter 13.

In short, if you’re thinking about a 13-to-7 conversion, go slow. Make certain you’re aware of the financial consequences and take steps to cure the problems that are within your power.

» Learn More: Pros and Cons of Chapter 7 Bankruptcy

How to Convert Chapter 13 to Chapter 7

Once weighing and measuring reveals a switch to Chapter 7 is your best option, it’s time to launch the legal process. Step-by-step, here’s much of what you can expect.

• File the appropriate forms: A notice of conversion, or a Statement of Intention, begins the process of alerting interested parties about your plan to switch chapters.
• Prepare for a creditors’ meeting. Yes, even if you attended one for your Chapter 13 filing, circumstances have changed that affect those to whom you are indebted.
• Learn about updates to your exemption status.
• Creditor payment claims transfer to your Chapter 7 case; if nonexempt property is sold, new creditors (if any) will have an opportunity to file proof of claim.
• Take the second debtor education course (if you haven’t already) to qualify for a Chapter 7 discharge.

How to Qualify to Convert to Chapter 7

Typically, qualifying for a Chapter 7 bankruptcy requires passing a means test, which is based largely on the applicant’s income. In basic terms, you pass the means test if your income is less than the median incomeyou’re your state.

Whether you have to pass a means test to convert from Chapter 13 to Chapter 7 depends on your local jurisdiction. Some courts require a fresh test; others do not.

“The court will evaluate the debtor’s income levels and ensure that their income is not above the limits established in Chapter 7,” Gavin says, according to the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA). “So long as the debtor qualifies and the conversion is not in bad faith, the court generally grants the motion to convert.”

The Chapter 7 means test calculates whether your income is low enough, or is stretched thin enough (by a large family, or high but reasonable expenses), to qualify for liquidation bankruptcy.

» Learn More: Chapter 7 Bankruptcy Income Limits

Forced Conversion to Chapter 7

Bankruptcy courts can, and do on occasion, force bankrupts to convert to Chapter 7, enabling a trustee to sell some nonexempt assets to pay creditors.

However, bankrupts who act in good faith rarely are forced into Chapter 7 conversions. If you’re unable to put together an acceptable payment plan, or you have a valid reason for missing a payment, your Chapter 13 case is more likely to be dismissed than converted — but you will lose the protections of bankruptcy against creditors.

Can I Convert from Chapter 13 to Chapter 7 without Losing my House and Car?

Whether you can hold onto possessions precious to you, including your dwelling and/or your vehicle, are key factors as you ponder whether to pursue the 13-to-7 conversion.

The simple answer is: It depends. Gavin calls it a “large, fact-based issue that depends on the state in which the debtor resides.”

Typically, you can hang onto both if your loan payments are current. Otherwise, depending on your state’s exemption rules, you may have to surrender them to the trustee.

If, before you filed for Chapter 13 bankruptcy, you were facing foreclosure on your home or repossession of your car, those processes may be re-triggered by a conversion to Chapter 7.

Exempt Assets

Exempt assets is the legal term that applies to personal possessions that cannot be sold off to pay creditors. Exemptions vary by state, and some states are far more generous than others.

Typically, assets that may be exempt from Chapter 7 liquidation include homes, vehicles, personal property, household goods and furnishings, appliances, and retirement accounts (401[k] and IRAs).

Reaffirmation and Redemption

Bankruptcy law provides a couple of ways to hang onto secured property — your house or car, for instance — during a Chapter 7 case. These are not possessions that, while not subject to the trustee’s gavel, are at risk of foreclosure or repossession.

You can reaffirm the debt(s) during the Chapter 7 case, which means you accept the debt(s) as valid and promise to pay it/them, even though it/they could be discharged (eliminated) in bankruptcy.

The lender and the court must be persuaded to approve your reaffirmation. You also may have to show you are current on your payments and have the means to keep up future payments.

Redemption involves paying the fair market value of the property you want to keep, regardless of the loan balance. This could be useful if you owe more for the possession — a car, perhaps — than the car is worth. The trick is finding the payoff money. As a bankrupt, you may find getting a fresh loan from traditional lenders difficult, and the terms expensive.

Discharge after Conversion

A discharge is the finish line of any bankruptcy. It means the terms of the case have been met, and the debts eligible to be eliminated are erased. However, debtors who have received a Chapter 7 discharge within the previous eight years are ineligible for an additional discharge.

Get Professional Help with Bankruptcy

Unlike changing your oil, building a deck, whipping up an exquisite beef bourguignon, or improving your chipping skills around the green, bankruptcy is far too complicated to learn via YouTube. Everybody picking over your application and overseeing your progress will be a professional with, most likely, years of successful experience.

Debtors who find themselves going through, or on the precipice, of bankruptcy, should enlist the skills of legal counsel and financial advisors.

A competent and engaged bankruptcy attorney is essential to the best outcome for a debtor seeking that coveted financial fresh start. Here’s a guide for finding just the right bankruptcy lawyer.

“A good consumer debtor’s attorney is part lawyer, part therapist, part confidante and part dispenser of tough love,” Gavin says. Here’s his checklist of benefits provided by an able attorney.

• Open and frank discussions about how the debtor arrived at this point.
• What the future really looks like.
• How the debtor can improve their circumstances.
• Advocacy for the debtor’s goals (as long as they are legal and reasonable).
• Counseling on problematic habits, such as tardiness, fudging the truth, or camouflaging important details.

“The goal is to leave the client better than you found them,” Gavin says.

Credit counselors, too, are interested in boosting woe-begotten debtors. Consumers who find themselves awash in unsecured debt, such as credit cards and medical bills, have options shy of any of bankruptcy’s several chapters.

Nonprofit credit counseling agencies have experts on staff who not only have seen the worst of personal financial disasters, but also have the training and experience to help guide their clients to better ways and better days.

Before committing to bankruptcy, or a 13-to-7 conversion, contact a credit counseling agency. There’s no obligation, and fresh, well-informed eyes may see a happier way out.

» Learn More: Credit Counseling vs. Bankruptcy