What is Chapter 13 Bankruptcy?
Individuals looking to declare bankruptcy may choose to file a Chapter 13 bankruptcy claim. Filing Chapter 13 bankruptcy allows the debtor consolidate his debts and get a discharge after making monthly payments for a period of 36-60 months. Any individual with a regular income, with less than $394,725 in unsecured debts and less than $1,184,200 secured debts is eligible to file a Chapter 13 bankruptcy claim. Secured debts are loans that have a property attached as collateral, a creditor has a right to repossess the property in cases of default, while unsecured debts do not have collaterals like credit card debt.
A debtor who files for Chapter 13 bankruptcy is obligated to make monthly payments to the appointed trustee for the entirety of the bankruptcy period, three to five years. The Trustee is then tasked with settling the debtors existing debts, settling creditors claims on his behalf. Throughout the duration of the process, the debtor need not come into contact with his creditors. The creditors are also prohibited from contacting and harassing a debtor who has filed a Chapter 13 bankruptcy.
Chapter 13 bankruptcy prioritizes secured debts, debts that have a collateral, and over unsecured debts. Payments from the repayment plan first go towards settling all secured debts first, then the balance, usually very little or none, is paid to creditors of unsecured debts. This usually results in a huge chunk of debt getting wiped off and discharged at the end of the bankruptcy period. However, some unsecured debts have priority status as well. Domestic payments like spousal and child support payments, and taxes are priority payments under a chapter 13 bankruptcy repayment plan.
Chapter 13 bankruptcy is essentially a reorganizing of the debtor’s finances in order to settle debts. The debtor experiences a change in lifestyle, as all disposable income is directed towards the monthly payment plan established and administered by a Trustee. Disposable income is calculated by subtracting a debtor’s reasonable and essential expenses from his total income, whatever is left after the subtraction is the monthly payment.
Filing a chapter 13 bankruptcy claim triggers a ‘stay’ on all debt recollection action. This is most often done in cases of house foreclosure. Filing bankruptcy under chapter 13 immediately stops the foreclosure proceedings, as long as it is done before it has been concluded. Chapter 13 bankruptcy gives you the leeway to make up for a missed mortgage or car payments without the house or car getting foreclosed or repossessed. Regular monthly payments will then continue either within the Chapter 13 Bankruptcy payment plan or independent of it.
The duration of a chapter 13 bankruptcy plan is determined by the debtor’s average income compared to his state’s median income. If a person’s average income over the six months that preceded the bankruptcy is higher than the state’s median income his bankruptcy will last for five years (60 months). If the average income is below the state’s median the bankruptcy can last from three to five years. Chapter 13 has a minimum duration of 36 months and cannot last more than 60 months. All debts that remain after the bankruptcy period is discharged and forgiven.
Advantages of Chapter 13 Bankruptcy
Individuals looking to enter bankruptcy are usually met with two popular choices, filing under Chapter 7 or entering bankruptcy under chapter 13. Chapter 7 bankruptcy usually lasts for 6 months and then the debt is discharged but chapter 13 bankruptcy lasts anywhere between 36 to 60 months. Despite this seemingly long period of time in bankruptcy the benefits of chapter 13 bankruptcy are numerous and can help a person take control of his financial life.
The following are some of the advantages of chapter 13 bankruptcy:
1. Prevents Home Foreclosure
Families or individuals may fall short of their mortgage monthly payments due to a number of reasons. With chapter 13 bankruptcy they are able to keep their homes while they try to get their finances in order for the duration of the bankruptcy. Mortgagers are usually quick to foreclose a property and sell it to recoup the balance they are owed. ‘Automatic Stay’ is triggered upon filing for chapter 13 bankruptcy. Banks or other lending institutions cannot foreclose and take possession of your property while you are in bankruptcy.
Chapter 13 bankruptcy gives you the chance to make a comfortable repayment plan for your mortgage arrearage. Mortgage arrearage is the sum of the missed mortgage payments you have incurred, these payments are then stretched across a 3-5 year period. Rather than get your house for closed, filing under chapter 13 will allow you the chance to pay the backlog of mortgage payment over a longer period of time.
However, it must be noted that your normal mortgage obligations remain intact. You must still make prompt monthly payments to your mortgage lender as they still have a lien, a legal right to foreclose your property if you default. Chapter 13 helps you catch up with accumulated missed payments but does not discharge your mortgage.
2. Altering Additional Mortgages
If you have more than one mortgage on your property, chapter 13 can help get rid of the extra mortgages. The first mortgage cannot be altered due to the provisions of the bankruptcy code, but the subsequent mortgages can be altered and transformed into dischargeable debt. You can successfully dispose of the second and third mortgages using a bankruptcy strategy called ‘lien stripping’.
Lien stripping is revoking the mortgage lenders legal right to repossess your property upon default on payments. This is done by weighing the worth of your property with the balance of your first mortgage. If your property is worth less than the first mortgage you can then apply to change the second and third mortgages into unsecured debts.
When you have stripped the liens of the second and third mortgages, you can then convert them to unsecured loans, since they do not have any collateral. Given their unsecured status, these mortgages join the rest of your other non-priority debts, receiving little to zero payment over the course of your bankruptcy. At the end of the bankruptcy period, the balance of the mortgages is wiped and discharged.
3. Ease Car Loan Payments
Filing chapter 13 bankruptcy immediately triggers an ‘Automatic Stay’. Your car loan creditors cannot be repossessed or make any debt collections actions. This allows you continued use of the automobile for the duration of your bankruptcy.
You can also vastly reduce the amount to be repaid by employing a process called ‘cramming’. Cramming down the value of a car loan means you reduce the balance of your debt to the current value of your car. Since cars are usually constantly depreciating this can shave a significant amount off your normal payments. If the car loan balance exceeds the current value of your car, you can create a repayment plan that only considers the present value of the car as the secured debt that will be paid off. The difference between the car’s current value and the car loan becomes an unsecured debt and receives minimal to zero payment and eventual discharge at the end of bankruptcy.
To employ cramming and cut down the of your debt, your car must have been bought not less than 910 days, that is two and half years, before the filing of bankruptcy. After successful chapter 13 bankruptcy, the lien on the car is removed and you gain full, unrestricted ownership of the vehicle.
4. Prevents Taxation Problems
Taxes cannot non-dischargeable and must be paid in full but with a chapter 13 bankruptcy filing, you can ease your issues with the tax collectors significantly. You can add your back taxes to you repayment plans, allowing you to repay your owed taxes without constant hounding and harassment from the IRS. Also, all fines and penalties resulting from prior taxation issues can be written off and discharged as unsecured debts.
5. Automatic Stay
This feature protects you from the constant pestering of creditors and collection agencies. As soon as bankruptcy is filed, all collection activities are required by law to cease immediately. Creditors cannot contact you or your cosigners over the repayment of a debt or even repossession of property. With chapter 13 bankruptcy, you do not ever have to communicate with a creditor for the entire period of bankruptcy.
6. Consolidated Debt
Chapter 13 bankruptcy allows you some form of succor, as your debt is managed by a court-appointed trustee. You make monthly payments to the trustee and they distribute the money among all creditors that have been listed and those who have made successful claims. All you need to do is make your monthly payments and you can be assured that the trustee is handling the creditor selling aspect. This way you do not have to keep track of each creditor individually at the risk of an oversight and failing to pay one of them.
7. Pause Student Loans Payment
Student loans are one of the largest debts Americans have today. While student loans cannot be discharged by law unless, in very rare circumstances, it is possible to delay or reduce payments.
You can choose to add your student loans to your chapter 13 bankruptcy repayment plan. If you do this, it is classified as an unsecured debt, but it is different from other unsecured debts as upon completion of bankruptcy you still continue payments once it is non-dischargeable. By adding it to your payment plan you greatly reduce the monthly payments you make, since it would barely get any servicing during the period of bankruptcy.
While you delay or make reduced payments on your student loans, you are able to get better employment or secure an additional source of income to help you pay up the debt after bankruptcy ends. You can get a discharge of your student loans when you file for bankruptcy using the ‘hardship’ clause. If you are able to prove that you have no means of student loans payment currently and that is not going to change in the future, a court can discharge and wipe of such a debt. You must show good faith during the proceedings in order to succeed, that is, you must show that you made reasonable steps to make payments towards the debt.
8. Retain Your Property
Compared to filing bankruptcy under chapter 7, chapter 13 allows the retention of all property. The courts only allow a person keep ‘exempt’ property when filing a chapter 7 bankruptcy claim. The definition of exempt is any property that is essential to starting afresh, making all nonessential or luxury belongings nonexempt and free to liquidate. All nonexempt property is sold in order to pay off the debt in chapter 7, but in chapter 13 your repayment plan is based on the monthly payments you pay to your trustee. You are allowed to keep your property and belongings without fear or repossession or foreclosure.
9. Cosigner Protection
Cosigners to your loans and your debts can be protected from creditors using chapter 13 bankruptcy. Since your cosigners are also liable to pay your debts, creditors have a right to go after them for payments of the amount owed. However, if you include the cosigned debt in your chapter 13 bankruptcy repayment plan, the ‘automatic stay’ extends to them. Creditors carry out any actions to recover debt form cosigners as long as the debt is contained in the repayment plan.
10. Discharge and A Clean Slate
After successfully completing your 3-5 years of bankruptcy, any balance on your unsecured debts is wiped off and discharged. This is a great way to get rid of insurmountable debts that may have been incurred due to mismanagement, bad luck, poor financial decisions, fraud or a myriad of other factors. A chapter 13 bankruptcy allows you time to get your affairs in order, repay your priority debts and wipes the slate clean after you adhere to the terms of your bankruptcy diligently.
The truth about bankruptcy is, you never pay more than a tiny portion of all your debt. Only priority debts like secured loans, mortgages and taxes are paid off during bankruptcy, the rest are paid with whatever money remains after the secured debt have been dealt with. This effectively frees you from the obligation to pay debts incurred from credit cards, utilities, and medical procedures, payday loans, parking tickets, fines and all other unsecured debt.
Declaring bankruptcy will also prevent you from getting stuck in perpetual indebtedness. Certain debts, like a credit card, have obscenely high-interest rates that only serves to build up the debt portfolio of such individuals. A lot of people are stuck paying off the interests on their debts rather than the actual original debt. When you declare chapter 13 bankruptcy interest stops running on debts. Meaning your debt portfolio can only drop rather than growing larger.
Bankruptcy might seem like low point and a dark period but it can also be a chance for a fresh start. Since you are free of draining financial burdens, you can commit to more profitable ventures, while learning from past experience and managing debt wisely.
Disadvantages of Chapter 13 Bankruptcy
Despite the many benefits of filing chapter 13 bankruptcy, there are still some drawbacks that come with the process. People looking to declare bankruptcy must consider the disadvantages of chapter 13 bankruptcy before filing.
Here are some of the cons and demerits of committing to the extended bankruptcy period filing chapter brings with it. Consider each carefully and weigh it against the benefits and your individual circumstance before making a decision.
1. Long Bankruptcy Period
Filing chapter 13 bankruptcy will take a minimum of 3 years to successfully complete and get a discharge. This extended period of time can be unnerving for people looking to get rid of their debts hastily and get back to their lives. For comparison, a chapter 7 filing will see the bankruptcy period last for only 6 months. The length of bankruptcy, coupled with the risk of dismissal due to a breach of terms can make a chapter 13 filing a risky endeavor. People who do not want to spend up to 5 years in bankruptcy should consult with an advisor to consider alternative plans.
2. Damaged Credit
A chapter 13 bankruptcy will stay on your credit report for 7 years, significantly reducing your credit score and also depleting your creditworthiness. This drop in credit score, which can be as much as 200 points, will have a huge impact on any transactions that require a credit check before a conclusion.
Declaring bankruptcy will make it almost impossible for you to get a mortgage unless you already have one. If you do get a mortgage you will be given really high-interest rates as you are flagged as a high-risk borrower. The conventional mortgage institutions will most likely fail to grant you a mortgage, you are going to be forced to seek out specialized institutions that cater to potential customers with poor credit scores.
A damaged credit will also make it impossible to obtain a new line of credit, like a loan or new credit cards. Borrowing or extending other lines of credit to people who have declared bankruptcy with the last 7 years makes it impossible. Most lines of credit would be accompanied by really high-interest rates and the need for cosigners and collateral.
3. Ruined Chances of Employment
Employers usually carry out extensive background and credit checks before employment. Declaring bankruptcy is usually considered to indicate poor management skills, below par decision making and a risky decision for such potential employers. Securing a gainful employment with the presence of a chapter 13 bankruptcy filing in the immediate past is highly probable.
4. Restrictive Lifestyle
For the duration of the bankruptcy period, your finances are effectively administered by the court-appointed trustee. Filing a chapter 13 bankruptcy leaves you with little or no financial freedom. Every earning, no matter its nature, is reported to the trustee who decides whether to adjust the monthly payment. People who are in chapter 13 bankruptcy commit their entire finances towards clearing their debts, there can be no spending on activities considered nonessential. All of your disposable income is handed over to the trustee for conversion into bankruptcy repayment plan.
5. High Administrative Costs
The cost of filing and successfully declaring chapter 13 bankruptcy can be quite high. The bankruptcy trustee, appointed by the court, takes 10% of your bankruptcy repayment plan as a commission for services rendered. The costs of hiring an attorney for the duration of 3-5 years can also constitute a significant portion of your repayment plan. In essence, the costs from the trustee’s commission, attorney fee, and court filing processing form a substantial percentage of the total cost, reducing the actual amount that goes to your creditors and extending the duration of payment.
6. Incomplete Discharge
Chapter 13 bankruptcy will not avail a person seeking to discharge any of the following debts- child and spousal supports; taxes; student loans; injury claims due to intoxication and driving under the influence; and mortgages. Chapter 13 bankruptcy merely extends the time allowed to pay these debts but does not offer a permanent solution towards the discharge of the entirety of person’s debt.
Recommendations
Filing a chapter 13 bankruptcy claim can be the first step towards reclaiming your financial life and pulling you and your household out of large, seemingly insurmountable debt. It is a viable alternative to a chapter 7 claim where you may have to lose your property in order to pay off debts. Filing under chapter 7 can help build good habits as you have to commit totally for the entirety of the bankruptcy period towards repaying your debts.
Before making a choice on what form of bankruptcy to file for, you must consult with an experienced professional. You will definitely need expert advice and assistance in making a smooth unhindered application for chapter 13 bankruptcy. The entire process can be quite complicated, but with the aid of experts with years of experience in bankruptcy laws, you are halfway to financial freedom.