How Does Chapter 13 Work?

Chapter 13 bankruptcy is a reorganization plan for individuals. It uses your disposable income over a three to five year period to pay some or all of what you owe to creditors. As you will see below, it’s a complex proceeding and is difficult to complete without the assistance of an attorney.

Why file a chapter 13 instead of a chapter 7?

If you are not eligible to file a chapter 7 case because you don’ t pass the means test, you can file a chapter 13 instead.

Another reason to file a chapter 13 plan is if your home is in foreclosure. The bankruptcy filing will stop the foreclosure and give you time make up the back payments over the course of the plan (3 to 5 years).

A third reason for a chapter 13 is to protect a co-debtor (someone who is jointly liable for one or more of your debts). If the co-debtor is someone other than your spouse (who can file jointly with you), such as your parents, a chapter 7 will not stop the creditor from collecting from the co-debtor. If you file a chapter 13, the stay will prohibit the creditor from pursuing your co-debtor.

Chapter 13 may also be the best option if you have assets that exceed the value of the available exemptions, such as a home with a lot of equity. In that case, however, you will likely be required to pay your creditors in full because a chapter 13 plan requires that you pay your creditors at least as much as they would receive in a chapter 7 liquidation. If you are in this situation, the only thing that chapter 13 can do for you is give you time (5 years) to pay your unsecured and priority creditors and to bring any past due payments current.

Who is eligible to file a chapter 13?

Any individual is eligible to file a chapter 13 provided that their total secured and unsecured debts do not exceed $2.75 million (up to $465,275 unsecured and $1,395,875 secured). Obviously, this limitation does not affect most people considering bankruptcy.

How much money do I need to pay creditors?

A chapter 13 plan provides for the partial or complete payment of your unsecured creditors. While the determination of what you will have to pay is a bit more complex than I make it sound, essentially, your net disposable income (what’s left after payment of your normal and necessary expenses) must be paid to creditors over a 3 to 5-year period. If your income is below your state’s median income for a family of your size, your plan must be completed within 3 years (unless extended by the Court). If your income exceeds the median, you have 5 years to pay creditors. Certain priority claims, such as child or spousal support and tax claims, must be paid in full.

Completing a chapter 13 plan isn’t easy.

The success of a chapter 13 plan depends in large part on how good you are at living on a strict budget for an extended period of time. While you are in a chapter 13 proceeding, you MUST keep your plan payments and payments on any secured obligations such as your home and your car(s) current. If you can’t do that, your case will likely be dismissed or converted to a chapter 7.

What happens if I miss a payment or two?

If you miss a payment (or more), your trustee can ask the court to either dismiss your case or convert it to a chapter 7. Treat the trustee as your best friend. If you get in trouble, your trustee should be the first person you call. If you are trying your best, and you miss a payment through no fault of your own, most trustees will work with you if you show a good faith effort to make your payments. If something like a job loss prevents you from making your payments for an extended period, you can seek a plan modification from the Court. If the trustee is in your corner, it will likely be granted.

Will I receive a discharge?

Upon completion of all your plan payments, you will receive a discharge and your creditors will have been “paid in full.” That means that, whatever they were paid under your plan, the obligation is deemed paid in full and you will not owe your creditors anything further. If you brought your mortgage payments current under the plan, your loan will be reinstated and any defaults will have been cured.

What are the downsides to a chapter 13?

There are a lot of downsides to a chapter 13, including:

  • Whether your plan is for 3 years or five years, you will have to live on a very strict budget for that period (no frills).
  • You must make all your plan payments, as well as your secured payments on your car(s) and home, on time. Your plan payments are made each month to your trustee. Depending on your location, and the practices of your trustee, you will either make your house and car payments to the trustee or directly to your lender(s).
  • No new debt can be incurred while you are in the chapter 13 without consulting your trustee.
  • A trustee’s fee equal to 10% of your total plan payments is added onto the amount you pay under your plan.
  • Chapter 13 is a complex and complicated proceeding that is best handled with the help of an attorney, which will cost more than the attorneys fees for a chapter 7 filing.
  • Most people who file a chapter 7 feel a huge sense of relief immediately. In chapter 13, that relief doesn’t come until you have completed all of your plan payments.
  • Only about 40% of chapter 13 debtors complete their plan and receive a discharge.
  • If you fail to make your plan payments, your case can be dismissed, leaving you (once again) at the mercy of your creditors.

If I have a choice, should I file a chapter 7 or a chapter 13?

I am confident that I am not alone when I say that, if you are eligible to file a chapter 7, you are better off doing so. The only exceptions to that advice are the ones listed above.

As with all matters pertaining to bankruptcy, the U.S. Bankruptcy Court’s website contains a wealth of useful information. Check it out.

If you still have questions and would like to talk to me, fill out the Contact form and we can set up a free half-hour telephone conference.

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