Bankruptcy

Chapter 13 Wage Earner Bankruptcy Basics

By Cara O'Neill, Attorney
Chapter 13 bankruptcy offers more solutions to debt problems than Chapter 7 bankruptcy. Learn whether filing for Chapter 13 bankruptcy is right for you.

Filing for Chapter 13 immediately stops collection activities, including most wage garnishments, lawsuits, foreclosures, and repossessions. You’ll be able to reorganize your debt so that it’s more manageable and:

  • catch up on missed car and mortgage payments
  • lower monthly payments on credit card balances, personal loans, and medical bills
  • stop the accumulation of interest and late penalties on some debts (but not all), and
  • pay off nondischargeable debt, such as recent income taxes, over three to five years.

Learn more about the unique benefits debt reorganization offers, how to qualify, and the Chapter 13 process.

Choosing Between Chapter 7 and Chapter 13

A Chapter 7 case works for many people because it:

  • doesn’t require payments to creditors
  • allows filers to keep essential property (luxury items are sold), and
  • takes only four or five months to complete.

But you won’t qualify if you have enough income to pay creditors some amount in a three- or five-year repayment plan. You’ll have to pass the Chapter 7 income qualifications (means test).

But failing the means test isn’t the only reason people file for Chapter 13. Chapter 13 solves problems that Chapter 7 can’t—so even if you qualify for Chapter 7, Chapter 13 might be the better option.

Here are some benefits unique to Chapter 13.

Keep All Property in Chapter 13

In both chapters, you get to exempt (protect) property allowed by your state’s bankruptcy exemption laws, such as:

  • an inexpensive car
  • clothing and household furnishings
  • some equity in your home, and
  • the funds in a qualifying retirement account.

If, however, you own nonexempt property that’s near and dear to your heart, you’d be out of luck in a Chapter 7 bankruptcy. The bankruptcy trustee would sell it and use the proceeds to satisfy creditors.

That wouldn’t happen in Chapter 13. You can keep everything you own (but it will cost you—find out about funding a repayment plan below).

Save Your Home or Car in Chapter 13

Falling behind on your mortgage or car payment will put you at risk of losing your home or vehicle. If you have enough income to catch up on the missed payments, filing for Chapter 13 bankruptcy can help.

The filing will stop the foreclosure sale or repossession immediately. You’ll make up the missed payments by spreading them out over your three- to five-year repayment plan and keep the property.

Wipe Out a Junior Home Mortgage

If your home is underwater (you owe more than it’s worth), you might be able to get rid of a second or third mortgage in Chapter 13. Here’s the rule: Your house must be worth less than the amount owed on a senior mortgage before you can wipe out a junior mortgage.

Put another way, suppose you sold your home but didn’t have enough to pay all of the mortgages secured by the house. If you were unable to pay any funds whatsoever to one or more of the junior mortgages, you’d be able to get rid of it through your plan. The fully underwater mortgage would be lumped with other unsecured debt, such as credit card balances, and any remaining balance would be wiped out at the end of your plan.

Reduce a Secured Loan With a Cramdown

You can reduce how much you owe on some secured loans by “cramming down” a high balance to the value of the collateral (the property securing the debt). Here are a few cramdown rules:

  • You can’t use a cramdown on a car loan unless you owned the car for 910 days before filing.
  • You can’t cramdown your residential home loan but you can cramdown a rental or vacation mortgage).
  • If you cram down a loan, you must pay the entire reduced balance through your repayment plan.

Receive Protection From Creditors While Paying Off Nondischargeable Debt

By filing for Chapter 13, you can force a creditor to give you three to five years to pay off nondischargeable debt without worrying about collection efforts such as a wage garnishment or bank levy. Nondischargeable debt commonly includes recent tax debt and support obligations. These must be paid in full in a Chapter 13 plan.

Lower Your Student Loan Payment Temporarily

If you have significant student loan debt in addition to other debt, you might be able to temporarily pay less on your student loan payment. And if you discharge other debt, you should have more money for your student loan after the completion of your plan.

Warning: Be aware that a Chapter 13 plan might interfere with the amount of time you’ve paid into an income-contingent or similar plan. Speak with a bankruptcy attorney knowledgeable in the current student loan rules.

File a Second Bankruptcy

If you received a Chapter 7 discharge within eight years but need to file for bankruptcy a second time, Chapter 13 might work. A Chapter 13 discharge is available four years after you last filed for Chapter 7 bankruptcy.

Discharge More Debt in Chapter 13

In Chapter 13, you can wipe out more debt types than you can in Chapter 7. Debts dischargeable only in Chapter 13 include:

  • Willful and malicious property damage. You can get rid of your responsibility to pay for property you purposely damaged (but not a willful injury to a person). For instance, suppose someone hit a man and threw his phone on the ground. In Chapter 7, the debt for the man’s hospital bill phone repair couldn’t be discharged. In Chapter 13, the phone repair bill could be discharged, but not the medical bill.
  • Some debt arising out of a divorce, separation order, or settlement. Chapter 13 bankruptcy discharges debt you must pay under a family law court order or marital settlement agreement as long as it isn’t for child or spousal support (which are never dischargeable). A typical example would be a “property equalization” payment.
  • Debt incurred to pay nondischargeable taxes. In Chapter 7, if you paid a nondischargeable tax bill with your credit card, you’d remain responsible for the credit card bill. By contrast, you can discharge it in Chapter 13. However, timing matters. Credit used shortly before bankruptcy could be considered fraudulent debt.
  • Post-petition homeowners’ dues. Instead of accumulating dues while waiting for title to transfer out of your name, some courts allow you to avoid incurring HOA dues if you surrender your home in Chapter 13.
  • Fines, penalties and forfeitures payable to a governmental unit. Debts for fines, penalties, and forfeitures that you owe to a city, county, state, or other governmental agency are dischargeable in Chapter 13—even if arising from fraud. You can’t discharge restitution or a fine included as part of a criminal
  • Other less common debts. You can discharge debt arising from a wrongful act committed against a federally insured bank or credit union; court fees incurred by a prisoner who files a lawsuit, motion, appeal or court document; and debts arising from securities law violations.

Are You Eligible for Chapter 13 Bankruptcy?

You must meet these requirements to qualify:

  • You’re an individual (businesses aren’t eligible, other than sole proprietors).
  • Your debt doesn’t exceed the current debt limits ( otherwise, you’ll file an individual Chapter 11).
  • You have sufficient monthly income to fund a repayment plan.

If you have a business, start by reading Small Business Bankruptcy Relief.

The Chapter 13 Repayment Plan

Drafting a repayment plan is complicated—so much so that most attorneys use software to complete it. Here are some of the primary components.

Plan Length

Your income determines whether you pay into a three or five-year plan.

  • Three-year plan. If your income is below the median income of your state, you’ll pay into a three-year plan, but you might want to propose a five-year plan if it lowers your payment for qualification purposes.
  • Five-year plan. If your income exceeds the median income of your state, your plan will last five years.

Monthly Payment Amount

You have to pay creditors your disposable income for the length of your plan. You’ll deduct reasonable monthly living expenses (as defined by law rather than your actual expenses in many cases) including a house and car payment.

You’ll also deduct the entire balance of the following debts (you’ll pay them in full in your repayment plan):

  • past due amounts on your house or car, and
  • priority debts, such as overdue tax bills and domestic support obligations (spousal and child support).

If you don’t have enough income to pay all of the above, it’s unlikely that the court will confirm a plan.

If you can pay all of the above, and you have income left over, the money remaining is disposable income. You’ll use all of it to repay nonpriority unsecured claims (debts that aren’t entitled to priority treatment or aren’t secured by collateral).

But there’s an additional step. The remaining creditors are entitled to receive a pro rata share (percentage) of whichever is higher:

  • your remaining disposable income, or
  • the value of your nonexempt property.

How to value nonexempt property. You’ll determine how much your creditors would have been paid had you filed a Chapter 7 case. For instance, if a Chapter 7 bankruptcy trustee would have sold a boat and distributed $10,000 to your priority unsecured creditors and $5,000 to general unsecured creditors, then you’ll have to pay those creditors at least that amount in Chapter 13 (and possibly more if you have significant disposable income).

You’ll start making your plan payments within a month of filing.

Plan Variations

Most people pay a small amount to nonpriority unsecured creditors. Others don’t pay anything to nonpriority unsecured creditors or must pay them in full.

  • The 0% plan. If you don’t have any disposable income after paying your house or car arrears, and you don’t have any priority debt or nonexempt property, you’ll be able to use Chapter 13 to keep your house or car and wipe out most unsecured creditors without paying the unsecured creditors anything.
  • The 100% plan. Sometimes you have a high enough income or own so much nonexempt property that you must pay your creditors in full. This type of case is informally known as a 100% plan.

Chapter 13 Plan Confirmation (Approval)

Once you file your proposed plan, your creditors and the trustee will have an opportunity to object. If no one objects, or if you successfully address all objections, your matter will go to a hearing before the assigned judge, and the judge will likely confirm your plan.

If the court doesn't confirm your plan, you’ll probably get additional time to correct any issues, but, if you don’t fix your plan within the time given, the court will dismiss your case.

Other Important Chapter 13 Events

Here are other things that you can expect:

Once you’ve satisfied your payment obligations and completed your plan, the remaining balance on any dischargeable debt will get wiped out.

If You Can’t Complete Your Chapter 13 Plan

If you aren’t able to make your monthly payment, talk to your lawyer. You might be able to:

  • convert (transfer) your case to a Chapter 7 case
  • ask the court for a hardship discharge, or
  • do nothing and allow the court to dismiss your case.

Keep in mind that you might lose property if you convert your matter to a Chapter 7 case. The court will likely use the exemptions you claimed in your original paperwork, so it’s important that you’re as accurate as possible when you prepare your initial paperwork.

Find out how much you should expect to pay for a Chapter 13 case by reading Chapter 13 Bankruptcy: How Much Does It Cost?

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