Bankruptcy doesn't mean that you get stripped to your shorts and thrown out on the street. Far from it. In fact, there are several different types of bankruptcy, all with their own procedures and rules, that are designed to accomplish different goals.
Chapter 13 is less about the elimination of debt (Chapter 7) and more about the reorganization of your finances. The Chapter 13 process requires that the debtor (that’s what we call the person who files the bankruptcy case) make a monthly payment to a Chapter 13 Trustee for a period of 36 to 60 months. The Trustee then distributes that money to the debtor’s creditors who have filed proper claims.
The Bankruptcy Code is the federal law that governs our bankruptcy court system. The Code is divided into numbered chapters and sections. Hence we refer to each type of bankruptcy by the number of the Bankruptcy Code chapter that covers it.
Chapter 13 vs. Chapter 7
Chapter 13 and Chapter 7 are popular choices for the average consumer. In theory, both options end up with a discharge of debt. You are relieved from the obligation to pay certain debts like credit cards and medical bills. The difference between 13 and 7 is how you get to the discharge
In a Chapter 7 case, you are required to turn over any nonexempt property. Exempt property is defined under federal or state law and is usually property deemed necessary for you to achieve a fresh start after bankruptcy. In a Chapter 7 case, you'd turn over all nonexempt property to a trustee, who sells it for the benefit of your creditors.
The Means Test
If you file for Chapter 7 bankruptcy, the court will apply something called the "means test." This test determines if you have the financial means to support the repayment plan that Chapter 13 requires. If the court determines you have enough money at the end of the month to pay down your debt, then you've "failed" the test and you're left with two realistic options: Chapter 13 or abandoning your pursuit of bankruptcy.
Your other option is to move ahead with Chapter 7 in the hopes you can prove that you aren't able to pay your debts. If you choose this route, you'll proceed under the "presumption of abuse," meaning you might be abusing bankruptcy laws by pursuing a full discharge when you have the means to pay back your debts.
In a Chapter 13 case, instead of turning over your property for a trustee to sell, you make payments for 36 to 60 months to a Chapter 13 trustee who distributes the funds to creditors who have filed claims that the court agrees are proper.
Why would someone file a Chapter 13 case that can last as long as five years when a Chapter 7 case usually lasts about six months? There are a number of factors that go into that decision.
Why File Chapter 13 Instead of Chapter 7?
Chapter 13 may provide you with bankruptcy protection even if you make too much money to qualify for a Chapter 7 case or if you received a discharge in a prior Chapter 7 case. You get the length of the plan to pay back past due amounts owed on houses, cars, and other loans that have collateral. Chapter 13 may allow you to set new terms for the payment of a car loan that is older than 2.5 years, too.
Chapter 13 allows you to pay past-due income taxes and domestic support obligations like child support and alimony over the three- to five-year payment plan. This form of bankruptcy protects any co-signers you have, and it could help you reduce high student loan payments.
Furthermore, Chapter 13 allows you to protect property that you'd have to give up in a Chapter 7 case. And, there's a chance you can roll your bankruptcy attorney's fees into your repayment plan.
Chapter 13 can be a lifesaver for individuals who are committed to making it a success. Chapter 13 cases, though, are not easy to live with. In fact, the American Bankruptcy Institute noted in a 2017 study that only 38.6% of debtors completed their Chapter 13 plan. But, knowing what to expect is one of the most important factors in setting yourself up for success.
The Chapter 13 Payment Plan
The hallmark of a Chapter 13 case is its payment plan. The payments last from 36 to 60 months and may include an amount that will go to unsecured creditors, past-due taxes, and past-due home mortgage amounts. It may even include car or house payments and some portion of your attorney fees. The payment plan is designed to:
- Help make payment of unsecured debts like medical bills and credit cards more affordable and manageable.
- Provide a way to pay past-due house, car, income tax, child support, and alimony payments over time.
- Substitute for the need to sell or turn over the nonexempt property.
The types and amount of debt you owe determine what your payments will be, as well as your income and your reasonable and necessary expenses.
Some flexibility can be built into payment plans and budgets to account for the unexpected, but it is difficult even for experienced bankruptcy attorneys and Chapter 13 trustees to account for everything that might happen.
You may not know for months after your case is filed if your proposed plan payments are acceptable to the Bankruptcy Court and the Chapter 13 Trustee. The trustee will verify your income and make sure your expenses are not too high. It takes several months for creditors to file claims and for all the players to review those claims. If you disagree with a claim, the bankruptcy judge may have to decide the dispute. This process can take several months to a year to complete.
Life After Bankruptcy
Filing bankruptcy no longer carries the stigma that it once did. Many people have filed bankruptcy over the last 40 years.
Despite the sheer numbers, people usually do not want to broadcast that they filed a bankruptcy case. Everyone respects that concern, but it is a fact that bankruptcy cases are public records. On the other hand, unless you have a reason to look at them, most people will never learn about your case.
There are exceptions, however. Many Chapter 13 trustees require that you make your payments through a payroll deduction. The trustee will send a form to your employer setting up that deduction.
If you feel strongly that being on a wage deduction will make things difficult for you at work, you can file a motion asking the court to allow you to pay the trustee directly. Courts will not allow direct payment unless you can show that you would be in danger of losing your job, being demoted, losing a security clearance or suffering some other serious consequence.
Besides your employer, others may learn of your case because of the notices every bankruptcy court must send to creditors. If your creditors include family or friends, they will get the notice and know about your case. Likewise, the court will send notice of your bankruptcy case to any co-signers on any of your loans or accounts.
You Still Have to Pay Your Bills While in Chapter 13
In addition to your Chapter 13 payments, you will still have to keep current on your:
- House and car payments (if they are not included in the Chapter 13 payment plan)
- Child support and alimony
- Property taxes
- Other expenses that you may have had difficulty paying in the past
If you got behind on your debt payments because you were out of work or had a decline in income, it may be very difficult for you to begin making those house, car, or child support payments again.
If you get behind on your house or car payments while you are in a Chapter 13 case, the lender can file a motion with the court asking permission to foreclose the home mortgage or repossess the vehicle. This is called a Motion to Lift Stay or a Motion for Relief From Stay.
If you are behind on your child support or alimony payments when you reach the end of your payment plan, the court will not issue you a discharge.
The Bottom Line
- Most debtors file either Chapter 7 or Chapter 13 bankruptcy.
- You'll typically file for Chapter 13 if you can't pass the means test to get Chapter 7.
- While Chapter 13 makes your payments manageable, many debtors fail to finish their repayment plan.
- You are responsible to pay all your other non-bankruptcy bills while you're in your Chapter 13 plan.