Chapter 13 Bankruptcy: Understanding the Basics
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When you hear the word bankruptcy, you may think of individuals erasing their debt and losing their assets in one fell swoop. While that’s true for some, many individuals file Chapter 13 bankruptcy, which doesn’t eliminate debt but helps people keep their assets and pay all or part of their obligations through a structured repayment plan.
In 2017, more than 765,863 individuals filed for bankruptcy, with nearly 40 percent of those filing under Chapter 13 of the federal bankruptcy code, according to the Administrative Office of the U.S. Courts.
If you’re facing financial troubles and considering declaring bankruptcy, you likely have some questions about what type of filing is right for you and the effect it will have on your credit score and assets.
Note: If you are dealing with an insurmountable amount of debt and feel like bankruptcy is your only option, click below to see if you qualify for other debt relief options.
Table of Contents
PART I: Understanding Chapter 13 bankruptcy
The U.S. Courts refer to Chapter 13 bankruptcy as a “wage earner’s plan.” It’s for individuals who have a regular income, but due to either bad luck or bad choices, cannot manage or repay all of their debts.
Under Chapter 13, the debtor gets help setting up a plan to pay creditors in installments over a three- to five-year period. During this time, creditors are not allowed to pursue collection.
Chapter 13 bankruptcy is generally looked on more favorably than Chapter 7 bankruptcy because unlike in Chapter 7, the debtor is paying at least some of what they owe. However, it will remain on your credit report for seven years from the filing date.
Who can file for chapter 13 bankruptcy?
Not everyone is eligible for Chapter 13 bankruptcy. To qualify, you must meet several legal and practical requirements.
Not for corporations.
“Corporations are not eligible, but sole proprietors are,” says Jen Lee, a debt and credit attorney in San Ramon, California. To qualify for Chapter 13, you have to do so as an individual.
Not barred by a prior bankruptcy.
If you discharged debt in a Chapter 13 bankruptcy within the last two years or in a Chapter 7, 11, or 12 bankruptcy within the last four years, you are ineligible for Chapter 13 bankruptcy until the waiting period is up.
Previous bankruptcy case not dismissed.
If a prior bankruptcy petition was dismissed within the past 180 days because you either violated a court order to appear before the court or requested that the court dismiss your case, you’ll need to wait until the 180-day timeframe has elapsed.
Fulfill credit counseling requirement.
Any individuals who file for bankruptcy are required to get credit counseling from an approved agency within a 180-day period before filing a bankruptcy petition.
Total debt within limits.
An individual must have unsecured debts of less than $394,725 and secured debts of less than $1,184,200. Unsecured debts are not backed by an underlying asset (e.g., credit cards, personal loans, medical bills and utility bills). Secured debt is backed by an asset or collateral (e.g., mortgages and auto loans). These amounts are adjusted periodically to reflect fluctuations in the consumer price index.
Current on income tax filing requirements.
You must be current on all income tax return filings when you file Chapter 13 and file all state and federal income tax returns that become due while your Chapter 13 case is open.
Plan pays all required debts and some unsecured debts.
Chapter 13 involves submitting a repayment plan to the court for approval. There are three classes of debt in a bankruptcy case:
- Priority claims – those granted special status by bankruptcy law including certain taxes, child support and alimony. These must be paid in full.
- Secured claims – If you want to keep your home and vehicle, then your plan must include keeping up with payments on your mortgage and auto loan.
- Unsecured claims – These do not have to be paid in full, as long as your plan provides that you will pay all of your “disposable income” toward these debts over the plan’s term. Also, your unsecured creditors must receive at least as much as they would have if your assets were liquidated to pay off creditors under a Chapter 7 bankruptcy filing.
Lee says the bankruptcy code requires an individual have a regular monthly income to file Chapter 13. “Practically speaking, you also need to be able to propose a repayment plan to the court that meets the requirements of the bankruptcy code and have enough income to make those payments.” She says many of her discussions with clients involve figuring out whether or not they can propose a feasible plan.
|Pros and cons of chapter 13 bankruptcy|
|You can keep assets including your home, car and other personal property||Will remain on your credit report for up to seven years|
|Collection efforts by your debtors must stop as soon as you file||May impact your ability to get credit, buy a home, buy a car, rent an apartment, or even get a job for quite some time|
When is chapter 13 the best option?
To understand when Chapter 13 bankruptcy is the best option, you first need to understand the difference between Chapter 7 and Chapter 13 filing.
|Chapter 7 vs Chapter 13 bankruptcy|
|Set up a plan to repay all or part of your debts while keeping your home, vehicle, and other personal property||Liquidate all non-exempt assets and use the proceeds to pay creditors|
|For debtors with a stable monthly income and the ability to make payments under the proposed plan||For low-income debtors with little or no assets|
|Cannot have more than $394,725 of unsecured debt or $1,184,200 of secured debt||No upper limit on debt|
|Receive discharge of eligible remaining debts after completion of repayment plan (usually three to five years)||Receive discharge of remaining eligible debts typically within three to five months|
|Allows the debtor to catch up on missed payments and avoid foreclosure or repossession||May not provide a way for the debtor to avoid foreclosure or repossession (depends on state law)|
|Remains on your credit report for up to seven years||Remains on your credit report for up to 10 years|
With those differences in mind, Chapter 13 may be your best option when:
You don’t qualify for Chapter 7.
If you cannot make meet your debt obligations but cannot pass the Chapter 7 means test, Chapter 13 may be your best options.
You have debts that are not dischargeable under Chapter 7.
Certain debts are never discharged in a Chapter 7 bankruptcy, including child support, alimony, fines and penalties for breaking the law, certain tax debts and debts arising from killing or injuring someone while driving under the influence of drugs or alcohol. If these debts make up the bulk of the debt you wish to discharge, Chapter 7 may achieve the desired result. Setting up a repayment plan under Chapter 13 may be a better option.
You want to repay debt.
Some people simply don’t like the idea of walking away from their obligations under a Chapter 7 bankruptcy and would prefer to work with creditors on a repayment plan.
You want to save your home from foreclosure.
If you are delinquent on your mortgage payments and facing foreclosure, filing Chapter 13 gives you an opportunity to save your home from foreclosure and get current on your mortgage payments.
Stop the repossession of your car.
If you are delinquent on your car payments and facing repossession, filing Chapter 13 gives you an opportunity to keep your car and get current with the finance company.
Wanting to keep nonexempt property.
Chapter 7 bankruptcy requires the debtor to sell certain assets and use the proceeds to pay their debts. You may be able to keep certain exempt assets, such as your home, one car, clothing and household item, but other personal property, real estate and investments may be liquidated. If you want to be able to hold on to property that would be liquidated under a Chapter 7 filing, Chapter 13 may be your best option.
Which debts are forgiven under Chapter 13?
Your Chapter 13 repayment plan may involve paying certain creditors less than full the full amount you owe. However, if you make payments as outlined in the approved plan, the remaining balance on those debts will be forgiven at the conclusion of your case.
Debts that can be forgiven include:
- Credit card debt
- Medical bills
- Some lawsuit judgments
- Certain debts arising from car accidents
- Obligations under leases and contracts (depends on what trustee wants)
- Personal loans
- Promissory notes (depends on bankruptcy clauses)
Other debts will not be discharged, including:
- Your home mortgage
- Alimony and child support
- Certain taxes
- Federal student loans
- Debts arising from killing or injuring another person while driving while intoxicated or under the influence of drugs
- Fines, penalties and restitution levied during your conviction of a crime
Forgiveness of certain secured debts, such as car loans, can be more complicated. In general, if you want to be able to keep your car, your repayment plan must include paying at least the value of the car to the finance company. However, if you financed the vehicle within a short time frame before filing for bankruptcy, you may be required to pay the car note in full, even if the car is worth less than the amount owed on the loan due to depreciation.
How does Chapter 13 affect my credit and for how long?
Bankruptcy will hurt your credit score, but the extent of its impact depends on over overall credit profile.
According to our study, Within two years of bankruptcy, 65% of people with a bankruptcy on their credit file have a credit score above 640.
According to myFICO.com, “someone that had spotless credit and a very high FICO score could expect a huge drop in their score. On the other hand, someone with many negative items already listed on their credit report might only see a modest drop in their score.”
You can expect a Chapter 13 bankruptcy to remain on your credit report for up to 7 years from the date filed. That’s three years earlier than a Chapter 7 bankruptcy because you’ll repay a portion of your debts under the Chapter 13 repayment plan.
During that seven-year waiting period, you can begin rebuilding your credit and bankruptcy’s negative impact on your score will lessen over time. In fact, you may be able to qualify for a conventional mortgage as little as two years from the discharge date of a Chapter 13 bankruptcy or four years from the dismissal date.
PART II: Filing for Chapter 13 Bankruptcy
Here’s an overview of the steps involved in filing for Chapter 13 bankruptcy.
Find an attorney
You can find plenty of bankruptcy information online, but your best course of action is speaking to an experienced personal bankruptcy attorney who is familiar with the laws of your state. While the natural reaction may be to put off dealing with the unpleasant aspects of your financial situation, delaying, transferring assets to friends and family members, and paying off the wrong creditors can make matters worse in the long run.
If you need help finding an attorney ask for a referral from your accountant, family attorney, friend, or call your local bar association. They maintain a list of bankruptcy attorneys in your area.
The federal Bankruptcy Code requires individuals filing for bankruptcy to get credit counseling within a 180-day period before filing a bankruptcy petition. If you are married, both spouses must attend credit counseling.
The credit counseling agency must be approved by the U.S. Trustee Program. You can find a list of qualified agencies from the U.S. Department of Justice.
Petition and paperwork
Next, you’ll file a petition with the bankruptcy court in your area. In addition to the petition you will also have to submit:
- A schedule of assets and liabilities
- A schedule of current income and expenses
- A schedule of contracts and unexpired leases
- A statement of financial affairs
- Certificate of credit counseling
- A copy of the debt repayment plan obtained in credit counseling (if any)
- Pay stubs (if any) for the last two months and a statement of any anticipated changes to your income and expenses after filing
- Documentation on any interest you have in 529 plans or other federal or state qualified education or tuition accounts
- A copy of your tax return or transcripts for the most recent tax year
Filing the petition automatically “stays” collection actions, i.e., prevents your creditors from foreclosing on your home, repossessing your vehicle, filing lawsuits, garnishing your wages, or even making collection calls.
The court is required to charge a $235 case filing fee and a $75 miscellaneous administrative fee. In most cases, you have to pay these fees before filing, but in some cases, the court will permit you to pay in installments over the course of 120 days. If you don’t pay these fees, your case may be dismissed.
You must file your repayment plan with your petition or within 14 days of filing your Chapter 13 bankruptcy petition, although the court can grant an extension.
The plan must outline the fixed amount you will pay biweekly or monthly to the trustee and how those funds will be distributed to your creditors.
After you file the petition, the court will appoint an impartial trustee to administer your case. It’s the trustee’s job to collect payments from you and make distributions to your creditors under the terms of the plan.
You must start making payments to the trustee within 30 days of filing your petition, even if the court has not yet approved your plan.
Meeting of creditors
Somewhere between 21 and 50 days after your petition is filed, the trustee will hold a meeting of creditors. During this meeting, you will be placed under oath and must answer questions posed by the trustee and your creditors. You (and your spouse, if married and filing a joint petition) are required to attend the meeting and answer questions about your finances and the terms of the proposed repayment plan.
Within 45 days after the meeting of the creditors, the bankruptcy judge will hold a confirmation hearing and decide whether your repayment plan is feasible and meets the requirements outlined in the Bankruptcy Code.
If the court confirms your plan, your appointed trustee will begin distributing funds to your creditors. If your plan isn’t confirmed, you can file a modified plan or convert your case to a Chapter 7 bankruptcy, assuming you qualify under the Chapter 7 means test.
The judge may also choose to dismiss your case, in which case the court may authorize your trustee to keep some of the funds you’ve paid to cover their costs. The trustee will return to you any remaining funds that haven’t been disbursed to your creditors.
Complying with the plan
If the judge confirms your proposed repayment plan, it’s up to you to abide by the repayment schedule outlined in the plan. You must live within your budget, make regular payments to the trustee as required, and not incur any new debt without consulting your trustee.
If you aren’t confident in your ability to make timely payments to the trustee on your own, you can make payments through payroll deductions. If you fail to make the agreed-upon payments, the court may dismiss your case or convert it to a Chapter 7 liquidation plan. The court can also dismiss your case if you fail to keep up with required child support and alimony payments or fail to file your tax returns on time while your case is open.
If circumstances arise that make it impossible for you to continue making payments to the trustee, you may be able to ask the court to modify the plan or grant a “hardship discharge.” This option is generally only available if your failure to complete the repayment plan is due to circumstances beyond your control, your creditors have received at least as much as they would have received in a Chapter 7 liquidation case, and modification of the plan is not possible.
Pre-discharge debtor education course
Before the court will conclude your case and discharge any remaining eligible debts, you must complete a course on personal financial management. The goal of this course is to educate you on personal finance so you won’t be forced to seek bankruptcy relief in the future.
You can search for an approved debtor education provider in your area via the U.S. Department of Justice.
Once you’ve successfully concluded the three- or five-year repayment plan, any remaining eligible debts will be discharged. Your creditors may not take any legal action or try to collect on the debts once they’ve been discharged.
While the repayment plan you propose under a Chapter 13 petition typically runs three to five years, Lee says there is a lot of planning that needs to be done prior to filing. “That may take a month, or it may take one or two years,” Lee says. All the more reason to talk to an attorney as soon as you realize you’re facing financial troubles that could lead to bankruptcy.
How to tackle debt without filing bankruptcy
Lee says, before filing for Chapter 13, you should think about your long-term goals and whether you can navigate your creditor problems without filing bankruptcy. The options Lee recommends may include:
With debt consolidation, you can roll all unsecured debts such as credit cards, personal loans, and medical bills into one new loan with one monthly payment. In most cases, you’ll also negotiate lower interest rates or a reduced balance with your creditors, so your payments are manageable.
Debt consolidation still has an effect on your credit score because you aren’t paying your debts as agreed, but its impact is typically not as severe as declaring bankruptcy.
Individual settlements on problematic accounts
If one or two particular debts are the source of your financial troubles, you may be able to negotiate a settlement with the individual creditors rather than filing for bankruptcy.
You may have an easier time negotiating a settlement after your debt has been referred to a collection agency. Offer a realistic monthly payment plan or lump sum. If the debt collector agrees to your settlement offer, make sure you get the agreement in writing before making any payments.
Watch out for companies that offer to negotiate with creditors on your behalf in exchange for a fee. Their fees can be quite expensive, and often the result is no better than you’d be able to negotiate on your own or with the help of your attorney.
“The caveat here is that a debt settlement program is not the same as Chapter 13,” Lee says. “In debt settlement, creditors are still able to use, get judgments, garnish wages and levy bank accounts. Chapter 13 stops all of those things from happening for the life of the bankruptcy.”
If you have cash in the bank or own other assets that can be sold to pay off your debt, this may be a viable alternative to declaring bankruptcy. Take into account any potential consequences. If you tap your retirement account to pay down debt, you may owe tax on the distribution as well as a ten percent penalty for early withdrawals. You could pay off one debt, only to find yourself owing the IRS.
Default on payments/ Do nothing
Ignoring your debt problems won’t make them go away and may even make your situation worse. Interest and late fees will continue to accrue while you do nothing and the debt collectors may initiate a lawsuit.
If you find yourself unable to pay your bills, work with a qualified credit counselor to explore your options and possibly set up a debt management plan. If that doesn’t work, seek out an experienced bankruptcy attorney who can help you navigate the bankruptcy filing process.
PART III: Life after Chapter 13
After filing a Chapter 13 bankruptcy, your credit score will be lowered, possibly by hundreds of points and the bankruptcy will remain on your credit report for the next seven years.
But you can begin rebuilding your credit much sooner. Avoid applying for any new credit while you’re working through your repayment plan, but once your case is successfully discharged, you can apply for a secured credit card. Use it responsibly and pay off your balance each month.
Use the lessons learned in your debtor education course to live within your means, use credit wisely, and pay your bills on time. Over time, your credit score will improve.