Chapter 13 Bankruptcy

What Is Chapter 13 Bankruptcy?

Chapter 13 bankruptcy is designed to assist individuals whose debts are out of control but who make enough money to repay their debts in part, or in full. Chapter 13 bankruptcy is sometimes called reorganization bankruptcy, and, after you make 3-5 years of monthly payments, many of your remaining debts are canceled.

Why File for 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 you 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 secured debt like mortgage payments.

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

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 and uses that money to pay your creditors.

Whether it’s  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 $465,275, and your secured debt can’t be more than $1,395,875

These figures are adjusted 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 your 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.

» Learn More: Can You File Bankruptcy Online?

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.

A major advantage of Chapter 13 is that a plan can be structured so that you can keep your home and car. When you file for Chapter 13, creditors cannot foreclose on your house or repossess your car. A payment plan can be designed so you can catch up on overdue payments. Of course, you’ll also have to keep up with current payments.

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 Chapter 7 is completed, allowing you to seek a reduction in whatever debts remain from a Chapter 7 discharge.

The Chapter 13 Process

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

1. Take a Mandatory Credit Counseling Course

Before filing for Chapter 13, bankruptcy laws require you to complete a credit counseling course from a U.S. Department of Justice U.S. Trustee Program-approved agency. This course helps assess whether you make enough money to pay back those you owe. The course must be taken within 180 days before filing for bankruptcy. The counseling fee is about $50.

2. File Chapter 13 Bankruptcy Paperwork

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

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 must stop hounding you for payments.

3. Attend 341 Meeting of Creditors

Within 40 days of your filing Chapter 13, the U.S. trustee will hold what is called a 341 meeting so your creditors and the trustee can ask about your finances. At least a week before this meeting, you must provide all requested financial documents to the trustee, including pay stubs, bank statements, four years of tax returns, and other records such as investment and retirement account holdings.

4. Begin Making Repayments

Although the court will not have finalized your bankruptcy plan, you’ll begin making monthly Chapter 13 payments the month after you file. The payments will be refunded if the bankruptcy court doesn’t confirm your plan. Car payments won’t be refunded but will be credited to your account. Payments will go to the trustee directly or through payroll deduction. If you fail to make the confirmed plan payments, the court may dismiss the case or convert it to a Chapter 7 liquidation case.

5. Complete the Confirmation Process

Within 40 days of the 341 hearing, a confirmation hearing to review your proposed plan will be held. Creditors or the bankruptcy trustee may object to the plan, and if so, your attorney will work to alter the plan so that everyone is satisfied. If the judge determines the plan is feasible that it is proposed in good faith and it complies with bankruptcy law, it will be confirmed. Judges typically give filers multiple opportunities to correct a plan before dismissing it.

6. Chapter 13 Bankruptcy Discharge

After completing all payments of the confirmed Chapter 13 plan, the court discharges your bankruptcy, which cancels the balances of qualifying debts. This does not include long-term obligations like a home mortgage, debts for alimony or child support, and certain taxes.

Eligibility Criteria for Chapter 13 Bankruptcy

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 3-5 years.

» Learn More: Filing Bankruptcy for Credit Card Debt

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 the court costs and back taxes they owed. They had to become current on their mortgage and car payments. The judge discharged half of 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 7 vs. Chapter 13 Bankruptcy

The biggest difference in Chapter 7 vs. Chapter 13 bankruptcy is 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 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 to fall 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 if 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 if 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.

» Learn More: How Long Bankruptcy Stays on Your Credit Report

Is Chapter 13 Worth It?

That’s a tough question. Chapter 13 has consequences – not only the 3-5 years you’ll be going through the plan, but the damage it does to your credit. It needs careful thought.

Although Chapter 7 bankruptcy is a quicker process, it means giving up many possessions that may mean a lot to you and your loved ones. The upside is that you can escape the pressure of debt collectors and start on the road to rebuilding your financial life.

Perhaps the best way to answer it is by asking another question: What’s the alternative?

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.