What is a Chapter 13 Bankruptcy?

Chapter 13 bankruptcy is a type of bankruptcy that provides relief for folks who make too much money to qualify for Chapter 7. At its core, it’s a reorganization that allows the filer to pay as much as their budget can handle instead of trying to keep up with each creditors’ minimum monthly payments.

After all plan payments have been made, and assuming the filer meets all other requirements set forth in the Bankruptcy Code, a discharge is entered, wiping out the remaining balances. But that just scratches the surface of how a Chapter 13 can help you deal with your debts and accomplish goals that you would not be able to accomplish in a Chapter 7 case.

How does a Chapter 13 compare to a Chapter 7?

The biggest difference to a Chapter 7 bankruptcy case is the steps a filer can take to reorganize their debt based on whether it’s secured, priority, or unsecured debt.

Things that are the same

Debt relief is immediate. The automatic stay goes into effect as soon as the Chapter 7 and Chapter 13 bankruptcy petition is filed with the court, stopping all collection efforts, including any garnishments you have been dealing with.

The bankruptcy forms that are filed for a Chapter 13 case are largely the same as for a Chapter 7 case, though some of the forms, including the means test form, are a little different. The filer doesn’t have to file a Statement of Intentions with the bankruptcy court, as their intentions with respect to their secured debts will be outlined in their Chapter 13 plan.

Chapter 13 filers also have to complete both the pre-bankruptcy credit counseling and the post-filing financial management courses through an approved agency and attend a meeting of creditors. In both types of bankruptcy, the filer is granted a discharge once all legal requirements for getting a discharge have been met.

Things that aren’t the same

The biggest difference between Chapter 7 vs. Chapter 13 is that the filer is required to make monthly payments to their bankruptcy trustee to pay a portion of their debts through their repayment plan. In a Chapter 7 bankruptcy, the trustee’s role is limited to investigating whether there are non-exempt assets that can be sold for the benefit of unsecured creditors. If none are found, creditors don’t get paid. If non-exempt assets exist, the Chapter 7 trustee sells them and uses the proceeds to pay each unsecured creditor their share.

In a Chapter 13, the bankruptcy trustee functions as a plan administrator, who receives the filer’s monthly payments and distributes the funds according to the Chapter 13 repayment plan approved by the court.

If the filer has significant non-exempt property, the plan payment has to be high enough so that all unsecured creditors get at least as much through the Chapter 13 plan than they would have received in a Chapter 7. That’s called the best interest test. However, not having any non-exempt assets does not get a Chapter 13 filer out of the obligation to make regular monthly plan payments.

Is filing a Chapter 13 more difficult than filing a Chapter 7?

Even though the majority of the forms are the same, filing a Chapter 13 is much more difficult than filing a Chapter 7. As part of the case, the filer has to propose a plan of reorganization that meets all of the requirements set forth in the Bankruptcy Code. And even though most districts use some version of a model plan, taking full advantage of all that Chapter 13 has to offer typically takes a knowledgeable bankruptcy attorney.  

What are the advantages of filing a Chapter 13 bankruptcy?

Since the Chapter 13 process allows the filer to reorganize their debts and pay certain types of debt in full while discharging others, there are significant advantages to filing Chapter 13 over Chapter 7. Wage earners with a regular monthly income that’s high enough to pay their monthly living expenses and make a monthly plan payment can take advantage of the following features of a Chapter 13 bankruptcy.

Modify your car loan

A Chapter 13 plan can modify your existing car loan and as long as you meet the legal requirements (i.e. you’re not trying to pay less than what the Bankruptcy Code says you have to), the creditor will be bound by the terms of the plan. They can’t complain about not getting paid the full amount of the car loan.

Lower the interest rate

If the interest rate on your car loan is high, a Chapter 13 bankruptcy plan can reduce the interest rate to a much lower amount – usually around 6% or so. This will immediately make your car loan cheaper.

Lower the loan balance

If you’ve had the car for more than 910 days, your plan can lower the balance owed to the current fair market value of the car. The waiting period prevents people from getting a car loan then turning around to modify it in a Chapter 13.

Example: Before filing, your car loan had a balance of $14,000 and an interest rate of 19.99%. You purchased the car 3 years ago, so the value is only around $6,000. In a Chapter 13 plan, you can propose to pay the creditor $6,000 at 6.5% interest and discharge the rest of the loan. When the plan is completed and your discharge entered, you’ll receive a clear title to your vehicle.

If you rolled in your old car loan when buying your current car, you may be able to lower the balance (at least the amount that was rolled over from your trade-in) even if it’s been less than 910 days since you purchased your current vehicle.

Catch up your mortgage or homeowners’ association

Unlike a Chapter 7, a Chapter 13 bankruptcy gives you the opportunity to catch up your mortgage (or HOA dues) over the term of the 3 – 5 year plan (and not in one large lump-sum payment that the bank may be demanding). This makes Chapter 13 a very powerful tool to fight off a looming foreclosure proceeding.

If you fell behind on your mortgage, maybe because you were unemployed for a while, but now you can afford to make the monthly payment again, Chapter 13 can get you back on track so you’re completely current with your mortgage (or HOA) payments when your case is done.

Some districts have a Mortgage Modification Mediation Program that helps bridge the gap between the bank and the homeowner and streamlines the process of determining whether you’re eligible for any of the modifications offered by your lender.

Eliminate your second mortgage or HELOC

If your home is worth less than the total amount owed on your first mortgage, you can remove or “strip” the second mortgage or home equity line of credit (HELOC) from your home. This process, often requiring an adversary proceeding, will turn the bank holding your second mortgage into an unsecured debt to be discharged at the conclusion of the plan. As long as you receive a Chapter 13 discharge, the bank will have to remove the lien from your property, so you’re only left with the first mortgage and forever freed from the obligation to pay the second mortgage or HELOC.

Keep your non-exempt property

In a Chapter 7, property that is not protected by an exemption is sold in order to pay unsecured creditors. As long as you pay enough into your plan to cover the value of your non-exempt property, you’re able to keep it.

Protect your cosigners

If a family member or friend cosigned a debt for you, the automatic stay in a Chapter 13 case extends to them as well. The same is not true in a Chapter 7. Additionally, you can potentially classify this debt separately so that you can pay it off as part of your payment plan, even though it’s a nonpriority general unsecured debt.

Pay off nondischargeable priority debts

Certain debts can’t be discharged in bankruptcy and some of those non-dischargeable debts are priority debts. The most common examples for this category are tax debts and child support. In a Chapter 7, you’re left owing this debt after your case is done and your discharge is entered. In a Chapter 13, you can pay these types of debt off in full through the Chapter 13 plan. So, while you may not be able to discharge your recent tax debts, you’re still able to eliminate the burden of owing it by paying it off as part of your case.

Student loans

Even though student loans are for the most part nondischargeable in bankruptcy, they are not considered a priority debt. If you’re hoping to deal with your student loans through a Chapter 13 bankruptcy, make sure to speak to a knowledgeable bankruptcy attorney in your area to find out how that would work.

What are the disadvantages of filing a Chapter 13 bankruptcy?

Some of the disadvantages of filing Chapter 13 are more obvious than others. Chapter 13 is not a solution for all situations, and even if it’s not a bad idea for you to pursue Chapter 13 bankruptcy, there are some disadvantages you should be aware of.

The payment plan

When a Chapter 13 is filed with the court, you commit to making payments for 3 – 5 years. That means up to five years of having to adhere to a strict budget (though one could argue that this isn’t a total disadvantage as you’ll be able to use your new financial management and budgeting skills after bankruptcy) and may have to increase your plan payment if your income goes up. The Chapter 13 trustee will also review your tax returns every year and may require you to submit your refunds to his office in addition to your regular plan payments.

Student loans

Depending on your specific situation and whether you’re allowed and able to make ongoing payments on your student loans while your Chapter 13 is pending, you may end up owing more on your student loans than when you first started.

It’s complicated

Chapter 13 is powerful, but complicated. That’s why approximately 98% of Chapter 13 cases that are filed without an attorney representing the filer fail. So, anyone filing Chapter 13 bankruptcy should hire a bankruptcy lawyer to help them succeed.  The good news is that you can pay a portion of your attorney fees through the payment plan over time.

How do I know if Chapter 13 is right for me?

This is a pretty complicated question, but you can start by looking at some of the basics. The first question you should ask yourself is whether you have a regular income. Chapter 13 is called the wage earner bankruptcy because its success relies on the filer’s regular income. If you’re commission-based, a gig worker, or unemployed, Chapter 13 may not be right for you.

If you do have regular income, take a look at your monthly expenses. Ignore credit card payments, car loans, and other loan repayments. Do you have money left over at the end of the month if you don’t have to make all the minimum payments to your creditors? If so, Chapter 13 may be right for you.

Are you eligible for Chapter 13?

The ability to propose a plan of reorganization in good faith is just one part of determining your eligibility. That one, you can determine at least on a baseline level by comparing your income to your expense is one part of the eligibility requirements for a Chapter 13 bankruptcy.

The other limitation imposed on Chapter 13 filers is a debt limit. You can’t have too much debt of a certain kind and file a Chapter 13 bankruptcy petition. The limits are adjusted every three years, and pretty high, so most consumers don’t run into this issue. But, if you have six-figure student loan debt, you may.

Is Chapter 13 right for you?

If all of your debt is unsecured and you’re eligible for a Chapter 7 discharge, Chapter 13 probably isn’t right for you. But, if you have car loans or missed mortgage payments that you need to deal with, Chapter 13 might be exactly what you need.

Chapter 13 bankruptcy is right for you only if you can pay for all of your reasonable living expenses and make the plan payment without having to compromise on something.

While the plan payment is determined by your actual disposable income, the minimum amount it has to be also depends on your specific goals. Want to pay off that (crammed down) car loan? Your monthly plan payment has to cover at least that. Want to keep certain non-exempt personal property? Your plan payment has to cover that as well.

Chapter 13 is powerful, but you have to have the means to pay for it. If you’re $40,000 in arrears on your mortgage and making the monthly mortgage payments is still a stretch, filing a Chapter 13 to save your home (without trying for a loan modification) is likely not a good idea.

One way to look at whether Chapter 13 is right for you is to compare your proposed plan payment to your current car payment. If your plan payment is equal to or less than what you’re currently paying for your car loans every month, you will have more money for necessities in a Chapter 13 than you have now.  

Plan confirmation

A few things happen after a Chapter 13 is filed: The plan is filed; creditors are invited to file claims in your case and given a deadline to object to your plan. Objections happen if a creditor thinks they’re entitled to more than you’re providing for in your plan.

Ultimately, to make the plan binding on all parties – including all of your creditors – the bankruptcy court has to approve of “confirm” your plan. This part of the bankruptcy proceeding varies somewhat from district to district and generally includes a confirmation hearing before the bankruptcy judge. You are given the opportunity to address any creditor objections and are even able to object to creditor claims if you think they’re wrong.

Once the plan is confirmed and all remaining creditor issues are resolved, the bankruptcy proceeding goes on auto-pilot. The filer makes monthly payments, the trustee disburses the payments to creditors, and once a year the trustee reviews the filer’s tax return. Once the final plan payment is made, the filer is prompted to file (a) their certificate of completion for the post-filing bankruptcy course everyone has to take and (b) any local form the court may have adopted to verify certain information at the conclusion of your plan.

When do I get a discharge?

A Chapter 13 discharge is entered once all plan payments have been made and the filer has complied with all other requirements in the plan and the Bankruptcy Code. All dischargeable debts, including credit cards, medical bills, personal loans, deficiencies from a repossession are eliminated. The Chapter 13 discharge actually covers a little bit more than the Chapter 7 discharge, allowing filers to eliminate obligations related to a divorce proceeding, as long as they’re not based on alimony or child support.

What if I lose my job while I’m in a Chapter 13?

If you lose your job or otherwise experience a significant decrease in income while you’re in a Chapter 13, you’re not stuck! Remember, the goal isn’t to put you into a situation you can’t afford to be in. Depending on the circumstances you may either modify your plan or convert your case to deal with the loss of income.

Plan Modification

You can ask the court to modify your plan by lowering your monthly payments to deal with your reduction in income. The modified plan again has to be confirmed by the court and is subject to objections from your creditors and the trustee.

The Hardship Discharge

Another way to modify your plan is to ask the court for a hardship discharge. If – due to not fault of your own – are unable to finish the payment plan, and the hardship you’re experiencing is going to last a period of time – or maybe forever – you can ask the court for a hardship discharge. One of the requirements to get a hardship discharge is that your unsecured creditors have already received as much as they would have gotten had you filed a Chapter 7 in the first place, so the best interest test is met.

Conversion to Chapter 7

You can also convert – or change – your case from a Chapter 13 to a Chapter 7. A new trustee is appointed, and you’ll have to go to another meeting of creditors. The converted case will proceed like a regular Chapter 7, with the trustee looking for and selling non-exempt assets for the benefit of your creditors.

Conclusion

Chapter 13 bankruptcy can be a powerful tool, but it generally requires the help of an experienced bankruptcy lawyer. Since filing once, having the case dismissed due to some deficiency, and then filing another case can complicate things, it’s rarely a good idea to file Chapter 13 without the assistance of an attorney.

If you pass the means test, have mostly credit card debt, medical bills and other unsecured debts, Chapter 7 is likely better for you. If you’re worried about going through a Chapter 7 by yourself, see if you’re eligible for our help. Even if we can’t help, you can always check out our Learning Center to learn more about your options and potential pitfalls, and we can even connect you with a lawyer in your area if you’d like.