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 who 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.

    Sometimes called the Wage Earner’s Bankruptcy, Chapter 13 allows those with enough income to repay all or part of their debts an alternative to liquidation. It’s bankruptcy for those whose biggest problem is dealing with creditors’ demands for immediate payment, not lack of income.

    One of Chapter 13’s most attractive features is the chance to keep your home as long as you can pay the mortgage under a settlement plan.

    Under Chapter 13, people have three to five years to resolve their debts while applying all their disposable income to debt reduction. The option allows applicants to eliminate unsecured debts while catching up on missed mortgage payments. Short-circuiting home foreclosure is one of the option’s most attractive features. Though keeping your home can be a major relief, you’re required to spend years living under the supervision of a court-appointed trustee who will collect and distribute your payments.

    How Chapter 13 Works

    Chapter 13 bankruptcy is like Chapter 11, which applies to businesses. In both cases, the petitioner submits a reorganization plan that safeguards assets against repossession or foreclosure and typically requests forgiveness of other debts. They both differ from the more extreme Chapter 7 filing, which liquidates all assets except those specifically protected.

    No bankruptcy filing eliminates all debts. Child support and alimony payments aren’t dischargeable, nor are student loans and unpaid taxes. But bankruptcy can clear away many other debts, though it will likely make it harder for the debtor to borrow in the future.

    To be eligible to file for Chapter 13 bankruptcy, an individual must have no more than $394,725 in unsecured debt, such as credit card bills or personal loans. They also can have no more than $1,184,200 in secured debts, which includes mortgages and car loans. These figures adjust periodically to reflect changes in the consumer price index.

    One of Chapter 13 allows you to stop an effort to foreclose on your home. Filing a Chapter 13 petition suspends any current foreclosure proceedings and payment of any other debts owed. This buys time 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.

    The Chapter 13 Process

    The cost to file Chapter 13 bankruptcy consists of filing fees and fees charged by a bankruptcy attorney. Applicants need to pay a $235 filing fee to the bankruptcy court, as well as a $75 miscellaneous administrative fee. They also need to provide:

    • A list of creditors and the amount of their claims
    • Disclosure of the amount and sources of the debtor’s income
    • A list of the debtor’s property, as well as an accounting of all contracts and leases in the debtor’s name
    • A breakdown of the debtor’s monthly living expenses
    • Tax information, including a copy of the debtor’s most recent federal tax return and a statement of any unpaid taxes.

    Chapter 13 petitioners must stipulate that they haven’t had a bankruptcy petition dismissed in the 180 days before filing due to their unwillingness to appear in court. Also, anyone seeking bankruptcy protection, must undergo credit counseling from an approved agency within 180 days of filing a petition.

    Shortly after filing, the debtor also must propose a repayment plan.  A bankruptcy judge or administrator will hold a hearing to determine whether the plan meets the requirements of the bankruptcy code and is fair. Creditors may raise objections to the plan, but the court has the final say.

    Debtors can arrange to make up delinquent payments over time, but under Chapter 13 rules, all new mortgage payments from the time of filing must be made on time.

    The debtor also must work with a mediator, or trustee, who distributes payments to the creditors. The debtor is not required to have any direct contact with his or her creditors under Chapter 13. In fact, all creditors are required by law to cease any attempts to recover the debts covered under the Chapter 13 process if all terms of the agreement are being met.

    You must stick to the basics of your settlement. No late payments are permitted. You’ll be allowed to accelerate your payments, allowing you to 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, if necessary. Failure to comply with the terms, especially failure to make payments on time, could result in you case being dismissed.

    Meeting Qualifications

    Businesses, even sole proprietorships, cannot file Chapter 13. The bankruptcy code also prohibits stockbrokers and commodity brokers from filing under Chapter 13, even if their debts are personal.

    Individuals who can demonstrate they have the means to pay down debts are eligible to file. 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 you 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 bankruptcy court will review the debts and income statements, meet with creditors 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 bankruptcy applicant look like?

    Consider Steven and Cathy, a married couple with a home that carriers a $150,000 mortgage. Steven works, Cathy 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 workout plan that shows how Steven’s income can be used to make mortgage and car payments, and can repay part of the unsecured credit card debt. Their plan includes three categories of debt: priority, secured and unsecured.

    Priority claims, which must be fully paid, include the cost of the bankruptcy proceeding and taxes owed. Secured debts are those with collateral, like a house or a car, also must be paid in full according to the bankruptcy plan. Repayment of unsecured debts, like money you owe on credit and charge cards, is flexible. The judge will review your income and the length of the repayment plan, then decide how much you’ll owe your unsecured creditors. The amount could range from nothing to complete repayment.

    For Steven and Cathy, this means paying all the court costs and whatever back taxes they might owe. It also means they will become current on their mortgage and car payments. But the judge will decide how much they’ll need to pay the credit card companies.

    Once their plan is accepted, the couple will begin making payments to a court-appointed trustee who will be responsible for monitoring their progress and conveying the money to the creditors.

    Chapter 7 vs. Chapter 13

    Chapter 7 bankruptcy forces you to liquidate a great many assets to repay creditors. But the process can be concluded relatively quickly, and any wages and property you acquire after the bankruptcy filing, except inheritances, aren’t subject to distribution to your creditors. Typically, the entire process is completed within six months.

    But Chapter 7 has disadvantages, too. 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 debt are still obligated to pay.

    Seeking Chapter 13 protection allows you to keep all your property. It simply extends the amount of time you have to repay what you owe after the bankruptcy court issues its ruling. It is 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.

    Chapter 13 also protects your loan cosigners against collection efforts if the bankruptcy settlement obligates you to repay the debt yourself.

    There are disadvantages as well. Legal fees can be higher in Chapter 13 cases than Chapter 7 and your obligation to repay can last for years. In Chapter 7, the settlement ends most debt obligations.

    Life after Chapter 13 Bankruptcy

    Once the court approves a repayment plan, it is up to the debtor to make the budget plan work. Failure to make agreed-upon payments will bring the matter back to court for further review, which could include selling the debtor’s property to pay debts.

    Bankruptcy may give debtors a breather from creditors, but there is a penalty to be paid on their credit reports. Under the federal Fair Credit Reporting Act, a Chapter 13 bankruptcy will be listed on the report for seven years. Debtors in this situation may find it difficult to get additional credit for years.

    Chapter 13 bankruptcy can be a useful financial tool for people with serious debts who worry about losing their homes to bankruptcy. Anyone considering this course should consult a bankruptcy lawyer.

    Before Filing a Bankruptcy Petition

    Though bankruptcy filings are sometimes of only way to resolve debts, they are generally a final alternative. Before deciding filing for bankruptcy, consider steps to repair your debt.

    • Credit Counseling. Seek help from a nonprofit credit counselor. Churches, charitable organizations and government agencies might provide counseling without charge, or they can refer you to a counselor. The goal is to review your finances and suggest solutions for your debt.
    • Debt Management. The next step is to visit a nonprofit credit counseling firm that can devise a specific plan for managing debt. A plan might consider which debts to pay first and detail how your income will be applied to debt. You can meet with debt managers personally or use online tools to set goals and create a plan. The plan might involve establishing a repayment pecking order, having you focus on paying down high-interest debts first while making minimum payments on other debts. Debt management plans also take 3-5 years to complete.
    • Debt Consolidation. Some firms will, for a fee, work with your creditors to devise a debt consolidation plan. If you owe balances on multiple credit cards, a debt consolidator will create a plan that allows you to make a single monthly payment which will then be used to repay what you owe.
    • Debt Settlement. As a final step to remediate debt problems and avoid bankruptcy, a nonprofit debt settlement firm negotiates with creditors to reduce what you owe in exchange for a workable payment plan that you commit to. Though this strategy is hardly foolproof, creditors sometimes are willing to take reduced payments if they know they can recover part of what they’re owed.

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    Author

    Staff Writer

    Bill Fay is a journalism veteran with a nearly four-decade career in reporting and writing for daily newspapers, magazines and public officials. His focus at Debt.org is on frugal living, veterans' finances, retirement and tax advice. Bill can be reached at bfay@debt.org.

    Sources

    1. United States Courts. Individual Debt Adjustment. Chapter 13. Retrieved from: http://www.uscourts.gov/federalcourts/bankruptcy/bankruptcybasics/chapter13.aspx
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