About Chapter 13 Bankruptcy

Bankruptcy Fast Facts

IMPORTANT: We recommend you read Learn About Chapter 7 before continuing.

What are the similarities?

Chapter 13 and Chapter 7 share many benefits:

• A debtor can “discharge” (or wipe out) their liability on most debts permanently,
• She/he benefits from an automatic stay (complete protection from most collections, lawsuits, garnishments, foreclosure, and more).
• Exemptions allow you to keep your property throughout the bankruptcy process. There are even more protections within Chapter 13 (see below).
• You are able to let go of assets you no longer need or want and can wipe out the debt with them. If you let go of most assets outside of bankruptcy, the creditor can collect any money that was not raised through the sale (in addition to repossession fees).

What are the differences?

Chapter 13 can be considered a legal debt reorganization or consolidation program. It is important to note that this differs substantially from the usual services, as Chapter 13 forces your creditors to follow your terms. Debtors pay back only what they can afford, which is determined between them, the court and their attorney. Also, the payback plan lasts for three to five years - no longer. Because of the combination of these factors, our clients usually pay back only pennies on the dollar toward their debts! This option is like telling the creditors that you have made best efforts to pay them back, then you’re done! Like in Chapter 7, some debts are “non-dischargeable” meaning they are not wiped away in bankruptcy (like child support, most student loans and usually alimony). The good news is, those expenses are accounted for in the payment plan. The court and your attorney must ensure that you have the necessary disposable income to make your payments (which go directly to the court).

Why File Chapter 13?

Now you may be asking yourself, “Why would someone opt to file a Chapter 13 and follow a payment schedule when they could simply wipe away all their debt in a Chapter 7?”

Let’s take a look at some of the reasons:

1. The Means Test

This is an evaluation of your financial situation to determine if you receive too much income to qualify for a Chapter 7 bankruptcy. If you earn more than your state’s median income based on your dependents and other factors, you are ineligible to file a Chapter 7. Yes, even people who receive relatively high incomes sometimes have to file for bankruptcy. This is usually due to income reduction, job loss, a medical disaster, a failed business or assets spinning out of control. Each bankruptcy court has a different definition of what too much income is. Experienced bankruptcy attorneys are accustomed to what is considered normal with their local bankruptcy court.

2. Low Fees Up-Front

A common issue is hiring a bankruptcy attorney when you don’t have any money. When all other plans fail, some choose to file a Chapter 13, which can usually be paid and it requires less up-front payment. In Chapter 7 bankruptcy cases, all attorney fees for the filing must be made up front. That is because the Chapter 7 bankruptcy wipes out everything else you owe your attorney! But that is not the case with a Chapter 13. Don’t forget that you must pay the Chapter 13 trustee (the court bookkeeper) monthly during the payment plan. The trustee then takes the amount following certain procedures, and distributes it to the creditors. The attorney can get paid through the Chapter 13 plan, which is how attorneys can charge less for the process.

3. Additional Exemptions

In a Chapter 13 you can still retain property even if there aren’t enough exemptions to cover the asset’s equity. With a Chapter 7 bankruptcy, if you have a home with excess equity, you will be forced to surrender the home. But in Chapter 13, you can protect the “equity above exemptions” into the payment plan. This enables debtors to retain their most valued property, where a Chapter 7 would not allow.

4. Catch up on Delinquent Payments

In a Chapter 7, if you are behind on your mortgage or car payment when you file your case, you cannot keep those possessions. In a Chapter 13 you can catch up on the delinquent amount over a 3-5-year period. This option is extremely valuable to homeowners that are able to make their mortgage payment but are too far behind due to rough patch. Whether you’re behind by months or even years, you may be able to keep your most valued assets.

5. Strip the Unsecured Mortgage

It’s possible to completely “strip off,” an unsecured mortgage - not possible in Chapter 7. For example, let’s assume a home’s market value is $200,000, while the first mortgage payoff is $205,000 and the second mortgage on the house is $70,000. Using Chapter 13, an experienced bankruptcy attorney can remove your second mortgage. Just imagine wiping away the second mortgage on your home! No, it’s not too good to be true - it’s the power of bankruptcy.

6. Cram Down

Another important benefit of Chapter 13 is that it can reduce the amount owed on secured debts. A cram down provision allows debtors to pay the asset’s value and not its contract amount, which can be a huge money-saving method on upside down assets. The catch? Motor vehicles need to have been purchased 2.5 years ago, and any other property at least 1 year ago. Unfortunately, in most situations the cram down cannot be used on home mortgages.

7. Reduce Interest Rates

Chapter 13 can actually reduce the interest rate payable on quite a few secured debts. Again, home mortgages do not fall in this category. If you’ve locked in a furniture or auto loan at a high interest rate — If that’s the case, Chapter 13 may actually be able to lower your rate (not by much, but you could save hundreds or even thousands of dollars).

Conclusions

When qualified and free of asset protection issues, Chapter 7 is often the logical choice for washing away unmanageable debts. But many of our clients either make too much or own too much, so they turn to the flexibility of Chapter 13.

So which Chapter is right for you? It really depends on your situation, and that’s why it is highly recommended to consult with an experienced bankruptcy attorney. Consider all your options - and learn about the pros and cons of each Chapter and how they apply to your situation. There’s no need to continue stressing out over uncontrollable finances. Call the bankruptcy team at Lincoln Law at 800-404-0018 for a free consultation and learn about your debt relief options today.

How the Chapter 13 Payment Is Calculated

Your monthly plan payment reflects what you can afford — not what your creditors demand. The court looks at two tests:

1. Disposable-income test. Your average monthly income minus your allowed living expenses (housing, food, transportation, healthcare, and similar costs as defined by IRS and local standards) must flow into the plan for the benefit of unsecured creditors.
2. Best-interest test. Unsecured creditors must receive at least as much as they would have received if you had filed Chapter 7. This means if you have assets above your exemptions, that value must also flow through the plan.

The trustee reviews your income and expenses and may object if the payment seems too low. Your attorney helps you document allowable expenses to arrive at a fair and accurate figure.

Related Topics:

Chapter 13

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Frequently Asked Questions

How much is the Chapter 13 plan payment?

Your Chapter 13 payment is based on your disposable income — what remains after subtracting court-allowed living expenses from your monthly earnings. The payment must also be enough to cover priority debts in full (such as recent taxes) and to pay unsecured creditors at least what they would receive in a Chapter 7 liquidation. Your attorney and the trustee review the calculation before the court confirms the plan.

Can I file Chapter 13 if I am behind on my mortgage?

Yes. Stopping a foreclosure and catching up on missed mortgage payments is one of the most common reasons people file Chapter 13. The automatic stay halts foreclosure from the day you file, and the plan spreads the overdue balance over three to five years while you continue making your regular monthly mortgage payments.

How long does a Chapter 13 plan last?

Plans last three years if your income is below your state's median income, and five years if your income is at or above that level. The court must approve the plan before it takes effect, and you make monthly payments to a trustee who distributes the funds to creditors.

What happens if I miss a Chapter 13 plan payment?

Missing payments can prompt the trustee or a creditor to ask the court to dismiss your case. If dismissed, the automatic stay ends and creditors may resume collection. You may be able to ask the court to modify the plan if your income drops significantly, or to convert the case to Chapter 7. Contact a bankruptcy attorney quickly if you fall behind.

What debts are not discharged in Chapter 13?

Child support, alimony, most student loans, and certain recent income taxes not paid in full during the plan are generally not dischargeable. Those obligations must typically be paid in full through the plan or otherwise accounted for. Most other unsecured debt left at the end of a successfully completed plan is discharged.

Can I file Chapter 13 if my income exceeds the Chapter 7 limit?

Yes. Chapter 13 is available regardless of income level, as long as your total secured and unsecured debts are each within the statutory limits. For many people whose income is too high to pass the Chapter 7 means test, Chapter 13 is the primary reorganization option.