Many people think that bankruptcy is the final step to financial ruin. And, one has no choice when you cannot pay all your debt. Chapter 13 can be a soft landing for those with income but have fallen behind on some payments.
According to USCourts.gov, 223,270 Chapter 13 consumer cases were closed in 2020. The mean time interval from filing to closing was 1,120 days (up from 1,031 days in 2019), and the median time interval was 1,185 days (up from 976 days in 2019).
What is Chapter 13 bankruptcy?
Chapter 13 bankruptcy plan involves repayment. The monthly payment is based on what you can afford to pay. Creditors are free to object to the amount of money they get under a Chapter 13 plan, but once the bankruptcy court approves the project, the creditors are bound by the program.
A Chapter 13 bankruptcy discharge eliminates debt that is not repaid after completing the repayment plan. Since creditors do get some money, filers aren’t required to surrender any nonexempt property. In a critical difference from Chapter 7, Chapter 13 allows you to reduce the interest rate on your car loan and, in some cases, even the balance you owe.
Chapter 13 is reserved for people with stable incomes with specific debt limits who are appointed a trustee that will handle distributing the monies to the creditors over a three-to-five-year period. Filers can generally retain their home and automobile.
Who should file for Chapter 13 bankruptcy?
The main reason to file a Chapter 13 is to prevent the liquidation of all your assets. Sometimes called the wage earner’s bankruptcy, Chapter 13 is ideal for debtors whose most significant problem isn’t lack of regular income but rather addressing creditors’ demands for immediate payment. If you have enough income, Chapter 13 allows you to repay part of your debts as an alternative to liquidating assets.
One key benefit is the opportunity to keep your home as long as you can pay the mortgage and any additional amount required by your Chapter 13 repayment plan.
Under Chapter 13, people have three to five years to resolve their debts, though they’ll have to apply their disposable income to debt reduction. The option allows debtors to avoid unsecured debts while catching up on missed mortgage payments, thereby preventing foreclosure.
The debt limits change, but Chapter 13 cases are now permitted for individuals with unsecured debts of no more than $465,275 and secured debts of no more than $1,395,875 in all cases filed April 1, 2022, and later.
How does Chapter 13 work?
You are appointed a trustee. The trustee’s role includes reviewing the bankruptcy proposal, making recommendations to the court, and collecting and distributing creditor payments. Like Chapter 11, except in Chapter 13, a petitioner submits a reorganization plan that safeguards certain assets and requests forgiveness of other debts. The plan will have to be approved in a confirmation hearing.
To be eligible for Chapter 13 bankruptcy, a debtor must have no more than $465,275 in unsecured debt, like credit card bills, and no more than $1,395,875 in secured debts, like car loans.
There are three types of claims: priority, secured, and unsecured.
Priority claims are those granted special status by the bankruptcy law. A priority claim is a debt entitled to special treatment in the bankruptcy process and will get paid ahead of non-priority claims. These may include bank lenders, employees, taxes, suppliers, and investors who have unsecured bonds.
Secured claims are those for which the creditor has the right to take back the property if the debtor does not pay the underlying debt. Secured claims are claims for debts secured by an interest in the property.
Examples are mortgages, car loans, unpaid real estate taxes, and other property liens.
In unsecured claims, the creditor has no special rights to collect against particular property owned by the debtor. Unsecured loans include personal loans, student loans, and most credit cards.
The repayment plan must pay priority claims in full unless a particular priority creditor agrees to a different treatment of the claim or, in the case of a domestic support obligation, unless the debtor contributes all “disposable income” — discussed below — to a five-year plan. (11 U.S.C. § 1322(a).)
Chapter 13 offers more robust protections for your co-signers or guarantors than Chapter 7. Regarding co-signers, the balance of the debt they co-signed will generally be less after the debtor’s Chapter 13 discharge than it would with a Chapter 7.
The upside for the co-signer is that they are protected from collections harassment for the entire three-to-five-year duration of the Chapter 13 process. Creditors can ask the court to lift the automatic stay, but only under the following circumstances:
- Your co-signer or guarantor received the consideration (benefit of the deal) for the creditor’s claim.
- You aren’t proposing to pay the debt off in full through your Chapter 13 plan.
- The creditor will suffer irreparable harm if the stay remains in place.
What is the Chapter 13 “liquidation test”?
Chapter 13 plans have several requirements; if those requirements are not met, the bankruptcy court will not confirm the plan.
One such requirement is the “liquidation test.” This test requires that the Chapter 13 plan pays unsecured creditors as much as they would have been paid in a Chapter 7 filing. The liquidation test in Chapter 13 does not require any payments to unsecured creditors when all property has been exempted.
The Chapter 13 process
Bankruptcy is complicated and a highly specialized legal field. Filing will cost you some money. Before you decide, consult a bankruptcy attorney. Expect to pay $3,000 to $4,000 for a Chapter 13 with the help of an attorney.
Fees include attorney fees plus a $313 filing fee. The Bankruptcy trustee may charge a fee of $15 to $20 when you file. Aside from the filing fees, you’ll be required to obtain credit counseling and take a personal financial management course. That generally costs anywhere from $20 to $100, depending on where you file.
They also must provide:
- A list of creditors and their total claims
- Evidence of the amount and sources of the debtor’s income
- A list of the debtor’s property
- A list of monthly living expenses
- A copy of the debtor’s most recent federal tax return and a statement of any unpaid taxes.
If you file Chapter 13, it’s required that you haven’t had any bankruptcy petition dismissed in the six months before filing due to an unwillingness to appear in court. You also must undergo credit counseling from an approved agency within 180 days of filing a petition.
Shortly after filing, you’ll need to propose a repayment plan.
You also must work with a Chapter 13 trustee, who distributes payments to the creditors. You won’t be required to have direct contact with your creditors, and all creditors will be required by law to stop attempts to recover any debts covered under the Chapter 13 process, provided that the payment plan terms are met.
Check out this video for a step by step explanation of filing for Chapter 13:
Other Types of Bankruptcy Filings
The other common type of personal bankruptcy filing is Chapter 7. Chapter 11 is the most common filing option when a business is involved.
Chapter 7 bankruptcy basics
Chapter 7 bankruptcy is the simplest and most common form of bankruptcy. In Chapter 7, if the debtor has assets not protected by an exemption, a court-appointed trustee may sell the assets and distribute the net proceeds to creditors according to the priorities established in the Code. Chapter 7 is known as liquidation bankruptcy.
All bankruptcy cases are handled in federal courts under rules outlined in the U.S. Bankruptcy Code.
Chapter 7 bankruptcy can erase many types of consumer debt, including credit card debt and medical bills.
How does Chapter 7 bankruptcy work
A bankruptcy trustee will review your forms and documents. They’ll also hold your 341 Meeting of Creditors, where they’ll ask you basic questions about your financial situation.
A couple of months later, you’ll get a notice in the mail from the court letting you know that the court has granted you a bankruptcy discharge. Most honest people fill out their bankruptcy forms and complete the required steps to get their bankruptcy petition accepted by the court and their eligible debts erased.
What are the requirements for Chapter 7 bankruptcy?
Requirements to file for a Chapter 7 include:
- You must pass a means test that looks at your income, expenses, and assets.
- You cannot have filed a Chapter 7 in the past eight years or a Chapter 13 in the past six years.
- You cannot have filed a petition for Chapter 7 or 13 in the last 180 days that a filing was dismissed, or because of failure to appear in court or comply with court orders, or you dismissed your filing because creditors sued to recover the property, they had a lien on.
- A credit counseling certificate of completion before filing for bankruptcy.
Chapter 7 bankruptcy court filing fees
The bankruptcy court filing fee for Chapter 7 bankruptcy is $338. You must pay it when the bankruptcy petition is filed unless the court grants you an exception. Expect to pay around $1,500 to $3,000 with attorney assistance.
When deciding to file for Chapter 7 or Chapter 13 bankruptcy, you will be paying for other additional costs besides the filing fees. Think printing costs, mailing costs, notices, fees to file amendments, travel expenses, paperwork, long-distance phone calls, parking fees, lost wages, and cellular phone calls. The bankruptcy petition is typically 60 pages.
To save some cash, if you are unemployed, a low-wage earner, disabled or elderly, you might be able to explore whether your local bar association or a legal aid office can offer free or discounted help. Hire a professionally trained paralegal who can help with the paperwork and other miscellaneous assistance but keep in mind that they cannot dole out any legal advice.
If you proceed without an attorney, you can run into complications and lead to your case being dismissed, leaving you worse off.
Which types of debt can be erased by Chapter 7?
Nonexempt property debt can be sold by the trustee assigned to your case by a bankruptcy court. Chapter 7 bankruptcy can erase the following types of dischargeable debts:
- Credit card debt
- Medical bills
- Car loans
- Personal loans and payday loans
- Judgments from credit cards and debt collection agencies
- Utility bills
The moment someone files bankruptcy, an automatic stay goes into effect. The filing temporarily stops anyone from collecting any debts you owe them.
Which debts can’t be erased?
Exemptions that typically cannot be sold to pay creditors are non-dischargeable debts. In Chapter 7 bankruptcy, these include:
- Child support and alimony
- Recent tax debts and other debts you owe the government like fines
- Student loans can usually not be erased
Chapter 7 bankruptcy is usually the quickest, easiest, and least expensive chapter of bankruptcy to file. Filers must pass income qualifications under means testing to receive a bankruptcy discharge.
Chapter 11 bankruptcy basics
Chapter 11 bankruptcy is a reorganization bankruptcy. The filing can be done voluntarily or forced by three or more creditors when they petition the bankruptcy court. Businesses have four months to develop a reorganization plan within 120 days of the petition but can go as long as 18 months. If the company doesn’t produce a plan, creditors can propose one. There’s no time limit on completing the repayment plan, but most take six months to two years.
According to the U.S. Courts website, a debtor can still control the company and even borrow more resources without the court’s approval. The debtor brings the reorganization plan to the court with justification on how it will be profitable, and creditors can vote to approve the plan or not. But the debtor must also file several other documents to the court, not just the reorganization plan. These documents include:
- A list of all company assets and liabilities.
- A list of all income and expenses.
- A list of all executable contracts and unexpired leases.
- A statement of all financial affairs (marriage status, previous bankruptcies, property purchases or sold, gifts, bank and money market balances, etc.)
Areas where bankruptcy won’t help
It won’t discharge:
- Most federal student loans
- Alimony and child support
- Debts that arise after bankruptcy is filed
- Debts you’ve incurred in the six months before filing bankruptcy
- Certain taxes
- Loans that were obtained fraudulently
- Debts from personal injury while driving intoxicated
- It won’t help any co-signer
When you declare bankruptcy, your co-signer may still be legally obligated to pay all or part of your loan.
Considering filing bankruptcy? Here are the next steps
Bankruptcy can be a difficult time for any individual or business owner. Here are a few tips to consider before determining a bankruptcy plan:
- Get familiar with each type of bankruptcy chapter to determine the best fit for the debtor’s needs.
- Consult a bankruptcy lawyer. Bankruptcy laws are complicated. An experienced attorney will be familiar with the U.S. bankruptcy code and will be able to advise you on your best course of action.
- Consider the costs. Bankruptcy can be expensive for filers. It may not make financial sense to pay the various fees, depending on your financial situation and your debt.
- Consider other debt-relief options, including a debt consolidation company or taking a loan from your savings or retirement plan.
- Talk to a nonprofit credit counselor to discuss your options.
- Call creditors and try to settle debt amounts, especially for consumer debt like credit cards.
- Prepare for a massive hit from all three major credit bureaus. And expect the bankruptcy filing to stay on a credit report for several years.
- Treat bankruptcy as a last resort. It will affect your credit score for up to 10 years.
The bottom line
Bankruptcy is a serious matter, and it can provide relief for people struggling with debt. Chapter 13 may be a great option if you have an income and want to protect valuable assets such as a home or car. If Chapter 13 is right for you, make sure you are diligent about keeping up with the repayment plan, or you could lose the assets you are trying to protect.
Seek the advice of a bankruptcy attorney.
Chapter 13 has two ways to avoid liens, known as a lien cram down or lien stripping. A lien gives a creditor a legal interest in the property. It allows the creditor to claim the asset, sell it, and use the proceeds to pay the unpaid debt.
A “cram down” in a Chapter 13 bankruptcy allows you to reduce the principal balance. Cram downs involve the debtor converting a portion of the debt from secured to unsecured. It’s the ability to alter a loan term.
A lien stripping converts an entire debt amount from secured to unsecured.
If you still have your car when you file for bankruptcy, the automatic stay will be in effect and prevent the lender from repossessing it until the bankruptcy judge approves your Chapter 13 repayment plan. If your repayment plan includes your car payment, the lender can’t repossess your car during the bankruptcy or after if you are current on your payments.
There is the option of a car cramdown which reduces the loan balance on your vehicle, but it has its limitations.
It’s not valid for vehicles 910 days before you filed for bankruptcy, and you can’t use title loans for a cramdown.
While secured debt uses the property as collateral to support the loan, unsecured debt has no collateral attached to it. In secured debt, interest rates are lower with longer repayment terms and typically higher loan limits.
General unsecured claims are not secured by collateral and do not have priority: credit card debts, student loans, medical bills, and the unsecured portion of an under-secured creditor’s claim.
The attorney general appoints U.S. Trustees. They are employees of the Department of Justice and play a significant role in monitoring the progress of your case and supervising its administration. The U.S. Trustee is responsible for monitoring the debtor in possession’s operation of the business and submitting operating reports and fees. These bankruptcy trustees become the C.E.O. of the debtor, exercising day-to-day control as they deem appropriate. Their duties include evaluating and making recommendations about various debtor demands under the U.S. Bankruptcy Code.
The U.S. Trustee is responsible for supervising and appointing case trustees (a bankruptcy trustee) to bankruptcy cases, teaching them how to do their jobs. The case trustee or the bankruptcy trustee is the person who appears at the 341 meeting of the creditors to inquire about the debtor’s veracity of their bankruptcy. The case trustee liquidates the debtor’s assets in a Chapter 7 bankruptcy and pays the creditors out of the repayment plan in a Chapter 13 bankruptcy. Case trustees are paid a commission from the bankruptcy estate based on its size.