A Chapter 13 bankruptcy is a form of repayment plan. The Chapter 13 bankruptcy process involves the restructuring of a debtor's financial obligations.
- Bankrupt individuals make payments toward their debts through monthly payments over the course of a repayment plan.
- In most cases, debtors who complete a repayment program will receive a partial discharge of their total debts.
- A typical repayment plan lasts for five years, although some debtors will enter into shorter plans.
A Chapter 13 bankruptcy benefits a debtor by allowing debts that are presently due or overdue to be repaid on a longer schedule, with the total debt load reduced to an amount that the debtor can reasonably repay over the term of a court-approved repayment plan. During the course of the repayment plan, the debtor is protected from foreclosure, garnishment, levy, or similar consequences arising from debts and judgments that are included in the plan.
The repayment plan benefits creditors who, although not ordinarily repaid in full, would otherwise have to utilize a debt collection process to try to collect money from the debtor, or write off debts as uncollectable.
A Chapter 13 bankruptcy will appear on your credit report for up to ten years following discharge.
In a Chapter 13 Bankruptcy:
- You will propose a repayment plan through which you will repay a portion of your debts over a period of years, based upon the amount of your discretionary income;
- If the bankruptcy court approves your plan, the court will appoint a trustee to collect your payments, distribute them to your creditors, and to supervise your compliance with the repayment plan.
- You will have to pay the trustee's fee, which may be substantial.
This type of bankruptcy can be particularly useful for debtors who believes that their financial crisis is temporary, and that their income will continue to grow in the future.
Debtors should also take care to propose a reasonable budget, as most debtors find themselves unable to comply with the strict enforcement of their Chapter 13 plans, and end up dropping out of bankruptcy before their plan is completed.
Who Qualifies for Chapter 13 Bankruptcy
Chapter 13 bankruptcy is intended for individual debtors. Corporations and partnerships are not eligible to file for Chapter 13 protection.
In order to qualify for Chapter 13 bankruptcy, a debtor must have a legal source of income that exceeds the debtor's reasonable living expenses, leaving an amount of discretionary income that may be applied to payments over the course of the repayment plan. For this reason, Chapter 13 bankruptcy is sometimes referred to as wage earner bankruptcy.
The amount that must be repaid will depend upon the total amount of debt owed by the debtor and the amount of the debtor's discretionary income.
- Although unusual, in some cases repayment may be for the full amount of the debt.
- In other cases the debtor may pay off only a small percentage of certain debts, perhaps as little as ten percent.
- Most cases fall between the extremes.
During the six month period before filing a bankruptcy petition, debtors must meet with a qualified credit counselor for a review of their debt and options. Before a final order of discharge will be issued by the bankruptcy court, debtors must also attend money management classes at their own expense.
Although the limits don't affect most debtors, Chapter 13 bankruptcy is not available to debtors who carry a very large amount of debt, specifically noncontingent, liquidated debts. A debt is contingent if it is only payable based upon a future event that may not happen, and any other debt is noncontingent. A debt is liquidated if it has a determinable cash value. As of April 1, 2016, in order to file for Chapter 13 bankruptcy you must hold less than $394,725 in noncontingent, liquidated unsecured debt, and less than $1,184,200. in noncontingent, liquidated secured debt.
You will most likely be unable to file for Chapter 13 bankruptcy if you have filed and dismissed a Chapter 13 petition in the last 180 days, and should discuss any prior filing with your attorney.
As debtors prepare to file a Chapter 13 bankruptcy petition, they must meet with a credit counselor. Part of the credit counseling process should involve their creating a list of obligations that will be subject to repayment under a Chapter 13 plan, and to prepare a budget that reflects their living expenses and the amount that will likely be applied to the repayment plan.
Upon review of a budget, some debtors will realize that they will have great difficulty complying with a Chapter 13 repayment plan, or that they prefer not to live for years under that type of financial constraint. Others may determine that they will be better served by trying to resolve their debts directly with their individual creditors outside of the bankruptcy process, rather than going through a formal bankruptcy.
Some debtors choose not to file for Chapter 13 bankruptcy, as they do not wish to live under the years scrutiny by the bankruptcy court and trustee over the course of their repayment plan.
Secured vs. Unsecured Debt
Debts fall into two broad categories, secured debts and unsecured debts.
- Unsecured debts, such as credit card debts, have no collateral.
- Secured debts are secured by collateral, as with a car loan or home mortgage.
Unsecured debt is divided into two categories under bankruptcy law, priority unsecured debt, such as child support, spousal support, taxes and debts to the government, that are normally nondischargeable in bankruptcy, and nonpriority unsecured debt, such as credit card payments, personal loans and medical bills, that are dischargeable.
Chapter 13 bankruptcy is often a good option for debtors who have fallen behind in their payments on secured debts, as it allows debtors to keep possession of the collateral - usually their homes and cars - while catching up on payments through a court-approved repayment plan.
If a debtor faces significant debt that cannot be discharged in bankruptcy, the debtor may nonetheless benefit from the restructuring of debt that occurs under a Chapter 13 plan, but if little to no debt will be discharged as a result of the bankruptcy a debtor may benefit from exploring other options, such as attempting to directly settle debts with creditors.
Ineligibility for Chapter 7 Bankruptcy
In order to qualify for Chapter 7 bankruptcy , a form of bankruptcy that allows for a discharge without going through a repayment plan, debtors are subject to a means test that is designed to assess their ability to repay their debt. If a debtor earns income in excess of the state median income, and is able to repay 25% of his or her nonpriority unsecured debt, the debtor will be ineligible for Chapter 7 protection and must instead file under Chapter 13.
Debtors who file for bankruptcy may protect certain assets from their creditors under exemptions defined by state and federal law. Chapter 13 bankruptcy may benefit a debtor who has valuable non-exempt property that would be liquidated in the course of a Chapter 7 bankruptcy.
Difficulty Completing a Repayment Plan
Debtors should consider that even with the best of intentions, it is difficult to complete a Chapter 13 repayment plan. Only about 35% of debtors successfully complete their plans.
Although debtors will get credit for payments applied to their debts before the dismissal of their bankruptcy petitions for non-compliance, they lose the benefit of the reduction of their debt and creditors will again be able to pursue the full balance of any remaining debt.
If you do not believe that you can live under the plan's budget, you should consider alternatives to a Chapter 13 filing.
Once a debtor files for bankruptcy, the debtor's estate is immediately protected from creditors. That protection, known as the automatic stay, prohibits debt collectors from attempting to collect debts without the permission of the bankruptcy court.
Once the bankruptcy case is filed, debtors gain immediate protection against foreclosure, repossession of a car, eviction from an apartment, garnishment of wages or bank accounts, the cutting off of utilities, or other measures that creditors may take to try to recover monies owed prior to the filing of the bankruptcy petition.
After filing for Chapter 13 protection, a debtor must propose a repayment plan for any debts and obligations.
- The proposed plan will be reviewed by the bankruptcy court.
- If the plan is approved, the court will appoint a trustee to represent the creditors.
- The trustee will collect the debtor's payments, to distribute them to creditors, and to supervise the debtor's compliance with the court-approved repayment plan.
- The debtor will be required to pay the trustee's fee, which is built into the repayment plan payments.
Over the course of the repayment period, the bankruptcy trustee maintains control over the debtor's personal finances, and the debtor must submit any credit-related matters to the trustee for review and approval. That means that if the debtor wants to apply for a credit card, get a car loan, or apply for any other form of credit, the debtor must first get permission from the trustee.
The repayment period in Chapter 13 bankruptcy typically lasts from three to five years. During that time, the debtor must live under a strict, court-imposed budget that applies the debtor's discretionary income to debt repayment and leaves most debtors unable to afford any expense that the court deems nonessential.
- If the debtor's income increases during the first thirty-six of the plan, the trustee may seek an increase in the amount of debt to be repaid based upon the debtor's increased discretionary income.
- After thirty-six months an increase in income does not affect repayment plans and, if the debtor chooses, may allow a debtor to pay off the plan on a faster schedule than was originally anticipated.
When a debtor is having difficulty making payments under a Chapter 13 plan, the debtor may ask the bankruptcy trustee to modify the plan. Possible modifications include:
- Granting the debtor a grace period;
- Reducing the debtor's monthly payments; or
- Extending the repayment period without changing the total amount to be repaid.
A debtor may also consider converting the Chapter 13 plan to a Chapter 7 bankruptcy, or seeking the voluntary dismissal of the bankruptcy petition.
Strategic Bankruptcy Filings
Some persons who file for Chapter 13 bankruptcy protection do so strategically, with the goal of getting some time to get their finances in order while preventing a foreclosure or repossession of a vehicle.
- If a debtor is able to regain firm financial footing before the bankruptcy is resolved, the debtor may opt to petition for discharge of the bankruptcy petition and then to pay off the remaining debts in full.
- In the alternative, a debtor may use the time obtained through a bankruptcy filing to sell certain property, such as a house, prior to foreclosure or repossession. Sales following foreclosure or repossession often do not result in the recovery of full market value.
Non-Compliance With the Repayment Plan
A debtor may be discharged from a Chapter 13 repayment plan for non-compliance. A debtor who suffers a financial setback, such as a reduction or loss of income, may be able to get the repayment plan adjusted based upon their changed circumstances, but if a debtor is unable to make payments as required by the plan the trustee will likely move to dismiss the bankruptcy.
Following dismissal, the debtor will again be obligated for the full remaining balance due on any debts that were included in the plan.
Debtors who becomes unable to complete a Chapter 13 bankruptcy through no fault of their own may attempt to obtain a hardship discharge. Such a discharge is very difficult to obtain, and creditors may oppose any attempt to obtain a hardship discharge. To qualify for a hardship discharge a debtor must establish that:
- The debtor's failure to complete the Chapter 13 plan was due to circumstances for which the debtor should not be held responsible, such as permanent medical disability.
- The payments already made into the plan by the debtor have resulted in the unsecured creditors' receiving at least as much money as they would have received had the debtor filed a Chapter 7 bankruptcy; and
- Modification of the plan is not practical, meaning that the debtor must convince the court that it would not be possible to complete even a modified repayment plan.
With a hardship discharge, of the debtor's dischargeable debts, only unsecured, nonpriority debts are discharged.