Chapter 13 Bankruptcy Basics
As between the relatively short chapter 7 bankruptcy process and the 3-5 year commitment of a chapter 13 bankruptcy, most consumer prefer to file for chapter 7. In many ways, the bias towards chapter 7 is understandable. One of the big benefits of filing bankruptcy is the ability to start over financially and the faster debt relief is available, the better. While it is often not the first choice, chapter 13 does have advantages that we will go over in this post. We will also delve into some of the peculiarities and drawbacks to filing for chapter 13 bankruptcy.
The Benefits of Chapter 13
Catch Up on the Mortgage/Avoid Foreclosure. Chapter 13 bankruptcy has many benefits, perhaps the best known of which is the ability to stop foreclosure and allow a homeowner to get caught up on past due mortgage payments. Both chapter 7 and chapter 13 will at least temporarily stop foreclosure through a court ordered injunction called the automatic stay, however, in the event that you have fallen behind on your mortgage, chapter 13 bankruptcy can actually force your lender to accept past due payments in small installments over a period of years. While you pay back the past due payments, you stay in your home. It is important to note that, in order to prevent foreclosure, making the normal monthly mortgage payment will be required. Chapter 13 bankruptcy does not relieve this obligation. It does, however, allow past due payments to be repaid in reasonable installments over a longer period of time than usually demanded by a bank. Another post on this forum, How Bankruptcy Can Save Your Home, provides an example:
For example, let’s say you’re behind 6 months on your mortgage and your normal monthly payment totals $1,000. The bank asks that you pay the $6,000 in arrearages plus late fees to avoid foreclosure. Unable to come up with the money, you file chapter 13 bankruptcy. Now, rather than being forced to come up with $6,000 all at once, your past due balance is divided over 60 months. $6,000 divided by 60 is $100, so your mortgage payment will now be roughly $1,100. If you can maintain this slightly higher mortgage payment the bank cannot foreclose.
Modify Second Mortgages. Another mortgage related benefit of chapter 13 bankruptcy is the ability to lower housing costs by modifying second mortgages on a primary residence. If you’re home is underwater and the amount of your first mortgage exceeds your home’s value, it is then possible to “strip” the second mortgage lien. How is this achieved? First, a home appraisal will be ordered that will prove the value of your home and that you are underwater. Based on this appraisal, your attorney will file a lawsuit in the bankruptcy court seeking to remove the second mortgage lien from your home. If the appraisal is solid the second mortgage lender often doesn’t put up much of a fight knowing that the debtor has the right to remove their lien. Once the mortgage lien has been removed, the second mortgage balance is paid out at the same percentage as the rest of your unsecured debts.
Cram Down Car Payments. By making car payments through a chapter 13 plan, it is possible to reduce the interest rate and even the principle on your loan. The Bankruptcy Code allows debtors to “cram down” or reduce their car loan to equal the actual value of the vehicle. Attorney, Cary Gluesenkamp explains the cram down rules in this post, How to Force Your Lender to Lower Your Car Payments:
Prior to the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act (“BAPCPA”) of 2005, there were few restrictions on the ability of a Chapter 13 bankruptcy debtor to “cram down” a vehicle finance company’s claim. Since the enactment of BAPCPA, the rules for cram downs on motor vehicles have changed. If the motor vehicle was acquired within 2 ½ years (910 days) prior to the filing date of the bankruptcy, and the motor vehicle was purchased for the personal use of the debtor, the vehicle finance company’s claim cannot be crammed down or lowered. However, if the debtor purchased the vehicle for someone other than the debtor, or for business use, the prohibition on cram down for vehicles acquired less than 2 ½ years ago does not apply. Examples include a vehicle purchased for a child of the debtor, or a vehicle acquired for use in a business.
Reduce Unsecured Debt Such as Credit Cards. Although chapter 13 bankruptcy does not immediately “wipe the slate clean” as in a chapter 7 case, it does help to reduce credit card debt and medical bills. Depending on debtor’s income, chapter 13 bankruptcy can reduce credit card debt significantly, often requiring re-payment at pennies on the dollar. Unlike chapter 7 bankruptcy which is a liquidation, chapter 13 bankruptcy involves crafting a repayment plan to pay something back to unsecured creditors. Many debtors with significant expenses and relatively low income end up paying back a small percentage of their total debts over the life of their plan. Others, who have higher income or non-exempt property pay a higher percentage. For more information on the way a chapter 13 plan payment is calculated, read this post by attorney Lori Patton: Chapter 13 plan payments explained. Be assured that chapter 13 bankruptcy will help with unsecured debts such as credit cards and medical bills. It’s not a clean break like chapter 7 bankruptcy, but there is relief to be had, at the end of the plan chapter 13 debtors receive a discharge.
Protection for co-signors: A chapter 13 re-payment plan lasts for between 3-5 years. During that time, the automatic stay in a chapter 13 case prevents creditors from pursuing a co-signer of debts as long as the debt is a consumer debt and the co-signer is an individual. By contrast, chapter 7 bankruptcy provides no protection for a co-signer.
Retain Non-Exempt Property: Chapter 7 bankruptcy or “straight” bankruptcy involves the sale of non-exempt property to satisfy creditor claims. In many cases, debtor filing for chapter 7 retain all of their property, however, in the event non-exempt property exists chapter 13 bankruptcy allows for retention of the property as long as the non-exempt value is paid out over the life of the re-payment plan. The non-exempt value of property is paid out incrementally over the life of the payment plan.
Fee Flexibility. People who are contemplating bankruptcy are often in a pinch for cash and wonder how they will be able to pay for a bankruptcy attorney. Chapter 13 can help to defer the up front cost of bankruptcy by allowing the debtor to pay the attorney’s fee in installments through the chapter 13 payment plan. Many bankruptcy law firms will file chapter 13 cases for clients with only payment of the $274 court filing fee.
The Drawbacks
Long Commitment/Lack of Flexibility. As alluded to earlier in this post, chapter 13 bankruptcy involves a large time commitment. For those debtors with income above the median for a family of similar size in their state, the length of their plan will be five years. For those with income below the median, the plan will be for three. In either event, this represents a big responsibility. Many things can change over the life of a chapter 13 case and it isn’t always easy to change the plan as your life evolves and your income fluctuates. Once a chapter 13 plan has been confirmed, a court hearing will usually be required before it can be changed. While it’s not impossible to get a chapter 13 plan changed in the event your income goes down or your expenses go up, it’s not a walk in the park.
The Confirmation Process/Local Custom. As demonstrated by this reader question about a trustee requiring auto loans to be paid through the chapter 13 plan, chapter 13 bankruptcy can vary greatly based on the local rules of your jurisdiction. In essence, the chapter 13 trustee is the gatekeeper standing between you and confirmation of your proposed plan. Before a plan is confirmed, the trustee is very likely to suggest changes that will result in a greater payout to creditors. From 10,000 feet, each chapter 13 plan is evaluated under certain tests to determine whether it can be confirmed. The Best Interests of the Creditors Test requires that creditors will get just as much of a payment through chapter 13 as they would were the debtor’s assets liquidated in chapter 7 bankruptcy. The Best Interests of the Creditors Test makes sure that chapter 13 debtors pay creditors the equivalent value of non-exempt assets they own that would have been liquidated to satisfy claims in a chapter 7 scenario.
Discharge Trouble. Due to the sheer length of chapter 13 bankruptcy, it can be difficult for some debtors to maintain their plan payments. If plan payments aren’t made on time, the trustee will motion to have the case dismissed. Once the case is dismissed, the debtor finds themselves back where they started, the automatic stay has lifted and creditors are free to once again initiate collection activities. In essence, the five year time commitment increases the risk that some debtors will fall behind and be unable to finish their plan.
Potential Pressure From Attorney. While most consumer bankruptcy attorneys are looking out for the best interest of their clients, there are firms that operate strictly as a business. Because the fees for chapter 13 bankruptcy are usually close to double those of a chapter 7 case, some attorneys may recommend chapter 13 bankruptcy where it isn’t necessary or where chapter 7 might be a better fit. Charlotte bankruptcy attorney Jason Witt explains as follows:
Another pitfall of Chapter 13 since the bankruptcy reform in 2005 is the elimination of the “super” discharge in Chapter 13 that made it more attractive. This along with other factors have led to a significant decline in Chapter 13 cases and hence revenue for Chapter 13 offices. The cost to keep the Chapter 13 office solvent is being spread across a smaller pool of debtors leaving the Chapter 13 trustee searching for ways to raise revenue. One of the ways in some districts is to charge a premium on house payments paid though the trustee office. Although Chapter 13 may still be your best option please consider whether you can truly afford the “wage” earner plan that envisions 3-5 years of monthly payments. If your attorney seems overly anxious to put you in Chapter 13 and you don’t understand why, it may be time for a second opinion.
Conclusion
Chapter 13 bankruptcy can provide great relief to families who find themselves in financial distress, however the chapter 13 process is a big commitment. To learn more about your options, consult a bankruptcy attorney.
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