Chapter 13 bankruptcy: an overview

Considering bankruptcy can be scary, but it's part of the process when you need a serious solution for severe debt problems. 

Bankruptcy isn't a get-out-of-debt-free card, and it's complex. Chapter 13—the "wage earner's" bankruptcy—is a repayment plan that has potential pitfalls as well as a few advantages.

Start here to learn more about Chapter 13 bankruptcy—so you can decide whether it's an option that's worth pursuing over options such as debt consolidation or debt resolution.

How does Chapter 13 bankruptcy work?

When you file Chapter 13, you're asking for a plan to repay what you owe over time. You submit a request (called a petition) to the bankruptcy court. In your petition, you provide financial information and suggest a monthly payment you can afford.

To qualify for Chapter 13 bankruptcy, you must be current on your tax return filings. You need enough income to cover the required payments, and your debt can't exceed $2,750,000. 

A bankruptcy trustee (this is a person appointed by the court to manage your bankruptcy) reviews your information and decides how much you'll pay each month. You send a bi-weekly or monthly check to the court, and the trustee divides the money among your creditors. At the end of your plan period, if you have met the court's requirements, you receive a Chapter 13 bankruptcy discharge. This discharge wipes out any remaining account balances in your plan. 

Chapter 13 has some powerful advantages:

• Your creditors can't opt out. They have to accept whatever the court says you'll pay.

• At the end of your plan period, you're no longer responsible for any remaining balances. 

• Chapter 13 can help you with secured debts like car loans or mortgages if you've fallen behind on your payments. You can include ‌the past due amounts in your bankruptcy plan. This brings your accounts current and prevents you from losing your home or your car. You must make your payments as agreed going forward.

Chapter 13 costs more and takes much longer than Chapter 7 bankruptcy. But it can work for certain people:

• People who earn too much to qualify for Chapter 7

• Those who don't want to surrender their property to the court

• Consumers with certain debts that can't be discharged in Chapter 7

These folks can still use Chapter 13 bankruptcy to get out of financial trouble. 

The Chapter 13 journey 

The Chapter 13 bankruptcy process is more complex than Chapter 7. Very few Chapter 13 filers succeed without an attorney. So, in addition to a few hundred dollars in filing fees, plan on paying about $3,000 in attorney fees. (You can pay the attorney fees through your Chapter 13 payment plan.)

Here's a quick rundown of the Chapter 13 bankruptcy process:

• Complete a pre-bankruptcy credit counseling session and a Chapter 13 payment plan with an approved counselor. You'll attach this plan and your certificate of completion to your bankruptcy petition.

• Submit your petition to the bankruptcy court in your area. You'll list your assets, debts, income, and monthly expenses. Include your most recent tax return.

• Between 21 and 50 days after you file your petition, the trustee holds a "meeting of creditors." You must attend and answer questions.

• After the creditor meeting, the court schedules a confirmation hearing to finalize your plan. Some priority claims, like child support, must be paid in full. Non-priority claims, like credit card accounts, are paid only if possible after priority claims are satisfied. 

• You must submit tax returns every year so your payment amount can be adjusted if needed. You'll be expected to apply all of your disposable income to your plan. Your disposable income is what's left after you pay for essentials like housing, transportation, and groceries. 

Unlike a Chapter 7 bankruptcy, Chapter 13 doesn't require you to give up the things you own. But the value of your assets is considered when the court sets your payment amount. Your creditors are entitled to the same amount they'd get if your assets were sold off in a Chapter 7 filing.

Your repayment period is determined by your income. Low-income filers pay for three years. People who earn more pay for five years. At the end of your plan, the judge issues your discharge and forgives any remaining balances.

Is Chapter 13 the right fit?

Chapter 7 is the go-to bankruptcy for people with big debt problems and few assets that the court can take. But there are several reasons you might choose Chapter 13 over Chapter 7.

• Your income is too high for Chapter 7.

• You want to wipe out certain debts that can't be discharged in Chapter 7. For instance, if you paid your taxes with a credit card, that debt can be discharged in Chapter 13 but not Chapter 7.

• You don't want to give up property to pay creditors. If you'd prefer paying your creditors over time to losing something that's important to you, you can opt for Chapter 13.

Chapter 13 bankruptcy can be an effective tool for consumers to get rid of debt, but for the typical filer, it's not very effective. Most Chapter 13 cases fail. Because of the low success rate (and fee structure), it's a good idea to consider it a solution of last resort when other options just don't pencil out.

Living with a Chapter 13 bankruptcy plan

Chapter 13 can be extremely difficult. The court determines how much money you need to live on and requires you to pay the rest of your earnings into the plan. You'll have to do this until your creditors are paid off or your plan ends. Every year, the trustee will review your finances and adjust your payment if needed.

Living with Chapter 13 means paying close attention to your budget and paying bills on time. It doesn't have to be the end of all the fun, but you'll have to find creative and cheap ways to spend time with loved ones. 

What about new debt? There are three ways to take on new debt:

• Without the court's permission and outside the plan. That's not recommended—where will you get the money to repay the new debt?

• Request approval from the court after taking on the debt. If you borrow for medical purposes or another necessity, the court may approve the new debt and adjust your plan. The new creditor will also have to approve this.

• Request court approval before taking on new debt. This is common for things like replacing a car that becomes unusable. If the trustee approves the new loan, you can apply for a plan adjustment to afford it.

If things change and you can't afford your plan, you have three options:

• Plan modification: If you can't afford your plan and the reason is beyond your control, the judge might agree to lower your payment.

• Hardship discharge: If you have a serious and permanent change in circumstances beyond your control that prevents you from completing your plan, you might qualify to have your debts discharged early. 

• Conversion to Chapter 7: If you don't qualify for a hardship adjustment and a modified payment would still be unaffordable, you might be able to convert your bankruptcy to Chapter 7. You'll have to have paid your unsecured creditors at least what they would have received if you had filed Chapter 7. 

Alternative to Chapter 13 bankruptcy

Debt resolution means negotiating with your unsecured creditors to lower the amount you owe. Debt resolution and Chapter 13 have similarities, but there are no upfront fees for debt resolution. 

Most people who consider Chapter 13 are financially stressed, and it's hard to know when you file whether you'll end up saving any money. Debt resolution might be more effective if:

• You don't have a high level of confidence that you can get through the Chapter 13 program 

• You earn too much to qualify for Chapter 7

• You can't afford to repay your debts without partial debt forgiveness

The decision to file bankruptcy is very personal. Don't rush into it. Talk to a bankruptcy attorney and a debt consultant about your possible options. Attorneys often offer a free consultation, and here at Achieve, a debt evaluation is free.