Chapter 13 Bankruptcy

Debtors with a regular income can use Chapter 13 bankruptcy to cope with their overwhelming debts, but there are long-term consequences for consumers to take this route.

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Who Should File Chapter 13 Bankruptcy?!

Many people think of bankruptcy court as the final stop on a path to financial ruin, the only option left when repaying debts seems impossible. But there’s hope even in bankruptcy, and Chapter 13 of the federal bankruptcy code offers the closest thing to a soft landing.

Chapter 13 is sometimes called the Wage Earner’s Bankruptcy, and for good reason. Chapter 13 is bankruptcy for people who are making money but have fallen desperately behind trying to keep up with payments for things bought on credit.

Your debts are reorganized, and a program is set up to pay them. You should be able to keep your home after Chapter 13 bankruptcy as long as meet the requirements of the repayment plan established by the bankruptcy court.

Under Chapter 13, you have 3-5 years to resolve debts while applying all your disposable income to debt reduction. That means no-frills living, but the Chapter 13 option lets you eliminate unsecured debt like credit card payments, while you catch up on your mortgage payments.

You’ll also be supervised by a court-appointed trustee who will collect and distribute your payments.

How Chapter 13 Works

You must submit a reorganization plan that safeguards certain assets (like your house) against repossession or foreclosure and typically requests forgiveness of other debts.

That’s different from the more extreme Chapter 7 filing, which liquidates non-exempt assets.

Whether it’s a Chapter 13 or 7 or 11, no bankruptcy filing eliminates all debts. Child support and alimony payments aren’t dischargeable, nor are student loans and most taxes. But bankruptcy can eliminate many other debts, though it will likely make it harder for you to borrow in the future.

To qualify for Chapter 13, you must:

  • Have a steady income.
  • Not filed for a Chapter 13 bankruptcy for two years, or a Chapter 7 for four years.
  • Be current on your tax filings.
  • Not have unsecured debt of more than $419,275, and your secured debt can’t be more than $1,257,850.

These figures adjust periodically to reflect changes in the consumer price index.

Filing a Chapter 13 petition suspends pending foreclosures and payments of any other debts owed. This gives you relief from creditors while the court considers the plan, but it does not eliminate the debt. Hopefully, the bankruptcy plan will free enough of your income that you’ll be able to make regular mortgage payments and keep your house.

Advantages of Chapter 13 Bankruptcy

Basically, Chapter 13 buys you time to get your financial act together. It extends the amount of time you have to repay what you owe after the bankruptcy court issues its ruling.

Chapter 13 protects your loan cosigners against collection efforts if the bankruptcy settlement obligates you to repay the debt yourself. If you need to file a second bankruptcy, Chapter 13 has a two-year waiting period versus eight years for Chapter 7.

It’s also possible to file a Chapter 13 bankruptcy after a Chapter 7 is completed, allowing you to seek a reduction in whatever debts remain from a Chapter 7 discharge.

The Chapter 13 Process

First, find a bankruptcy lawyer who will give you a free evaluation and estimate on what you’ll have to pay to file.

The cost to file Chapter 13 bankruptcy consists of a $313 filing fee and fees charged by a bankruptcy attorney. As for documents and other information, you must provide:

  • A list of creditors and the amount of their claims.
  • Proof of income.
  • List any properties you own and any leases in your name.
  • List your monthly living expenses.
  • Provide tax information, specifically your federal tax return and any statements of unpaid taxes.

Chapter 13 petitioners cannot have had a bankruptcy petition dismissed in the 180 days before filing. They must also take a credit counseling course approved by the U.S. Department of Justice U.S. Trustee Program in that 180-day span.

After you (or your lawyer) file your paperwork, you’ll then get a letter from the court clerk notifying you, your creditors and your court-appointed trustee that collection activities on your accounts have been suspended. That means creditors have to stop hounding you for payments.

You will propose a repayment plan, and a bankruptcy judge or administrator will hold a hearing to determine whether it’s fair and meets legal standards. Creditors can object, but most judges allow filers to alter their plans several times.

You can make delinquent payments over time, but all new mortgage payments after filing bankruptcy must be made on time. You’re not required to have direct contact with creditors, and you can work with your trustee to distribute the payments

After that, it’s just a matter of sticking to your repayment plan. If you’re late or miss payments, the trustee could move to dismiss your Chapter 13 case. You don’t want that.

In some cases, you may be allowed to accelerate your payments and seek an early discharge from the agreement. Conversely, if your financial situation worsens, it’s up to you to inform the bankruptcy trustee and seek a modification of the plan.

Failure to comply with the terms, especially if you fail to make payments on time, and your Chapter 13 case might be thrown out.

Meeting Qualifications

Chapter 13 is for individuals, not businesses, such as corporations or LLCs. Stockbrokers and commodity brokers also cannot file, even if their debts are personal.

Individuals must show they have the means to make monthly payments. They must disclose their sources of income and submit the information to the court within 14 days of filing a petition. Income can come from a variety of sources, including pension income, Social Security payments, unemployment compensation, royalties and rent and proceeds from a property sale.

You also need to be current in your tax filings. You are required to submit proof that you filed state and federal tax returns for the past four years. If you can’t do this, your case can be delayed until you can, and will be dismissed if you are unable to produce or offer transcripts of your returns.

The trustee will review the debts and income statements, and then schedule a hearing to decide whether the plan is acceptable.  When the repayments are completed, the Chapter 13 case will be discharged. This typically takes three to five years.

Typical Chapter 13 Bankruptcy Case

What does a successful Chapter 13 applicant look like?

Consider Bill and Kathy, a married couple with a home that carries a $150,000 mortgage. Bill works, Kathy doesn’t, but they file jointly for Chapter 13 protection. The couple also owes $7,000 on a car loan and has nearly $20,000 in credit card debt.

Two weeks after filing a petition, they submit a Chapter 13 repayment plan that shows how Bill’s income can be used to make mortgage and car payments, and it can repay part of the unsecured credit card debt. Their plan includes three categories of debt: priority, secured and unsecured.

Priority claims must be fully paid. They include the bankruptcy filing cost, some taxes and child support. Secured debts with collateral, like a house or a car, also must be paid in full in most cases.

Unsecured debts, like credit cards, are negotiable. The judge will review your income and repayment plan and rule how much you’ll owe your unsecured creditors. The range is “everything” to “nothing,” so don’t prop your feet on the judge’s desk during the proceedings.

Bill and Kathy had to repay court costs and back taxes they owed. They had to become current on their mortgage and car payments. The judge discharged half their credit card debt.

The couple then began making payments to their trustee, who conveyed the money to creditors and monitored Bill and Kathy’s progress.

Chapter 13 and the CARES Act

The federal government rolled out all sorts of Covid-19 relief packages, and the CARES Act made bankruptcy filings available to businesses and individuals affected by the pandemic.

Among other things, repayment plans were extended to seven years. The bill was signed in March 2020, and many provisions have expired. Your bankruptcy attorney should be able to apply any provisions that are still applicable.

Chapter 7 vs. Chapter 13 Bankruptcy

In Chapter 13, you have a chance to keep all your stuff. In Chapter 7 bankruptcy, you probably can keep most of your “necessary” stuff (home, car you drive to work, clothes, tools for work), but will have to liquidate things deemed “non-exempt” by a bankruptcy trustee.

That’s the quick answer, though it’s not quite that simple.

With Chapter 7, you sell some or all of non-exempt things like your second car, any property you might own and things of value like art, stamp, coin or card collections. The process concludes within six months of filing. Any wages or property you acquire after filing, except inheritances, aren’t subject to distribution to creditors.

With Chapter 7, lenders who have already filed to foreclose on your home are only temporarily stalled, and other debts such as mortgage liens can be collected after the case is concluded. Cosigners on your debts are still obligated to pay.

Chapter 7 requires your income falls below the median level income for your state, or you must pass a means test. If you fail to meet the Chapter 7 income limit or means test requirements, Chapter 13 is the alternative.

Chapter 11 vs. Chapter 13 Bankruptcy

Chapter 11 is another type of bankruptcy. It is similar to Chapter 13 in that debt is restructured and paid back over time, but it was originally designed for large corporations, though small businesses and individuals are eligible.

Chapter 11 bankruptcy can get complicated and expensive, so most debtors choose Chapter 13 or Chapter 7 to avoid the time, costs and risks involved with Chapter 11.

But it’s a viable option if you don’t want to liquidate your assets, as required in Chapter 7, or you have too much debt to qualify for Chapter 13.

Life after Chapter 13 Bankruptcy

Chapter 13 can be useful for people with serious debts who worry about losing  their homes to bankruptcy. If you adhere to your repayment plan, you’ll have a new lease on financial life.

Unsecured debts will be gone, but mortgages and car payments might linger. Hopefully, you’ll have developed the habits needed to meet those obligations.

How does Filing Bankruptcy Affect Your Credit?

Filing bankruptcy will affect your credit score for as long as it appears on your credit report, though the negative impact does diminish over time. Chapter 13 bankruptcy stays there for seven years, while Chapter 7 is there for 10 years, and you should see your credit score recover throughout the years given you don’t have any financial hiccups along the way.

Chapter 13 also has less of a blow because – if you complete your repayment plan – you will at least have established a track record of paying your bills.

If you’re filing for bankruptcy, chances are your credit score wasn’t that good to begin with. If it was good, it will plummet 100-200 points, regardless of which chapter you use.

Before Filing a Bankruptcy Petition

Bankruptcy can resolve your debt problems, but you should consider it a last-gasp option. Before deciding if you should file for bankruptcy, look for alternatives or advice that might be a less damaging choice. Some possibilities include:

Credit Counseling – Nonprofit credit counseling agencies provide free budgeting advice and suggestions for other debt-relief options. Churches, charitable organizations and government agencies also provide counseling without charge, or they can refer you somewhere than can help. The goal is to review your finances and suggest solutions for your debt.

Debt Management – This is one of a few debt-relief programs that might make it possible to avoid filing bankruptcy. The primary goal of debt management is to reduce the interest rate on credit card debt and lower the monthly payments you make to an affordable rate. Debt management plans take 3-5 years to complete.

Debt Consolidation –If you owe balances on multiple credit cards, a debt consolidation loan will allow you to pay off all the credit card debt and be left with a lower-cost loan repayment. Your credit score will influence whether the interest rate you pay offers substantial savings or not.

Debt Settlement – It’s usually better than bankruptcy, but not by much. A debt settlement company negotiates with creditors to reduce what you owe in exchange for a lump-sum payment plan that you commit to for 2-3 years. Several negative factors make this a risky debt-relief option, but if it keeps you from having to file bankruptcy, it’s probably worth it.

About The Author

Bill Fay

Bill “No Pay” Fay has lived a meager financial existence his entire life. He started writing/bragging about it in 2012, helping birth Debt.org into existence as the site’s original “Frugal Man.” Prior to that, he spent more than 30 years covering the high finance world of college and professional sports for major publications, including the Associated Press, New York Times and Sports Illustrated. His interest in sports has waned some, but he is as passionate as ever about not reaching for his wallet. Bill can be reached at [email protected].

Article Reviewed By

Article Reviewed By

Patrick J Best - Bankruptcy Attorney

Patrick J. Best

Bankruptcy Attorney
Certified Financial Planner

Sources:

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