What Is Chapter 13 Bankruptcy?

Definition & Examples of Chapter 13 Bankruptcy

Couple looking distressed as they review bills together
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 Ariel Skelley / Getty Images

Chapter 13 bankruptcy allows a debtor to seek shelter from creditors and set up a debt repayment plan while protecting their assets from liquidation. It is a common type of bankruptcy, but it's only available to individuals with sufficient income to stick with the repayment plan.

When most people think of bankruptcy, they imagine a situation where a court swoops In, takes all their assets, and leaves them with little or nothing. But that is the classic view of a Chapter 7 straight bankruptcy case. Thankfully, for many who are overwhelmed by debt, Chapter 13 bankruptcy offers a choice.

What Is Chapter 13 Bankruptcy?

Although Chapter 7 bankruptcy is the most common, some individuals may qualify for a less drastic option. Under Chapter 13 bankruptcy, you have the opportunity to avoid foreclosure and reschedule payments for other debts. It consolidates these debts into one payment plan and prevents collectors and creditors from contacting you.

To be eligible for Chapter 13 bankruptcy, you must meet certain requirements:

  • Debt limits: You must have less than $394,725 in unsecured debts and less than $1,184,200 in unsecured debts. (These are 2020 numbers and they change with shifts in the consumer price index).
  • Compliance: You must not have willfully failed to appear in court, comply with court orders, or have been voluntarily dismissed after creditors sought payment via bankruptcy court within the last 180 days.
  • Credit counseling: Within 180 days before filing, you must have gotten credit counseling from an approved agency.
  • Income threshold: You must prove that you have enough surplus monthly income to meet the obligations of the new repayment schedule, as well as continuing payments on our mortgage and other secured debts.

These requirements apply to any individual, even ones who are self-employed or running an unincorporated business. Corporations and partnerships may not file for Chapter 13 bankruptcy.

  • Alternate name: The wage earner's plan

How Chapter 13 Bankruptcy Works

When you file for Chapter 13 bankruptcy, you'll file with your state of residence or where your business is domiciled. You will have to submit financial statements, tax returns, a list of all debt obligations, and a certificate of credit counseling, The courts will charge filing and administrative fees, which can typically be paid in installments.

The Payment Plan

Chapter 7 is a relatively brief process, and usually only lasts four to six months before the court issues the discharge. Chapter 13, on the other hand, will last from three to five years, depending on the length of a monthly payment plan the court accepts for you to pay certain debts.

The Chapter 13 plan period will vary based on whether your family income is generally above or below the median income for your state of residence. If your income is below the median, you'll usually have to take the 3-year plan.

The Chapter 13 plan, or simply the payment plan, is the heart of a Chapter 13 case. Chapter 13 is an attempt to "reorganize" your debt (or your joint debts with your spouse) over time. It's a great tool for the debtor who is behind in house payments or car payments. Those payments can be caught up with the payment plan over time, thereby saving the house from foreclosure or the car from repossession. The plan will also include any past-due priority claims, such as alimony, child support, or recent income taxes. 

The Chapter 13 plan can also include payments toward unsecured debt such as credit cards and medical bills. A calculation is applied to your income and expenses to determine if you have any disposable income after all your other obligations are met. You're expected to devote your disposable income to your plan payment, and that extra money will be used to pay unsecured creditors.

If you don't have enough disposable income to pay your unsecured debt in full over the course of the payment plan, the court will just require that your full disposable income go toward these payments. As long as your unsecured creditors get as much as they would have under Chapter 7, you'll meet your obligations.

Chapter 13 Trustee

The Chapter 13 trustee acts as the main point of contact for a debtor. The trustee will review the proposed payment plan and has the authority to challenge the plan in bankruptcy court if they believe that it is improper. If the Chapter 13 plan is confirmed by the bankruptcy court, the trustee acts as an intermediary between the debtor and creditors receiving payments. Specifically, the debtor makes payments each month to the trustee. The trustee then divides up the payment, as established in the Chapter 13 plan, and issues payments to the creditors.

When you file for Chapter 13 bankruptcy, you must begin making payments to the trustee within 30 days, even if the court as not yet approved the plan.

Restrictions During Chapter 13 Bankruptcy

Chapter 13 bankruptcy carries with it a few restrictions which are not present in Chapter 7 bankruptcy, the monthly plan payment being the most obvious. In addition, you will not be allowed to incur any more debt without court approval. As in any situation where you still hold liens against major assets, you will have to maintain insurance coverage on those assets.

Discharge

if you stick with your payment plan to the end, then any remaining consumer debt and eligible secured debts will be discharged. You may be left with debts that are not discharged, such as student loans. Chapter 13 discharge is personal, meaning that any cosigners may still be obligated to any outstanding debts once your Chapter 13 payment plan ends.

When you file for Chapter 13 bankruptcy, cosigners on any of the debts included in your bankruptcy filing are automatically protected from creditors until your Chapter 13 bankruptcy case is closed.

Chapter 13 Bankruptcy vs. Chapter 7

Chapter 13 Bankruptcy Chapter 7 Bankruptcy
Keep assets as long as you stick to the payment plan Liquidate nonexempt assets to pay off debts
Payment plan last 3 to 5 years Discharged within 4 to 6 months
Possible loan balance reduction No loan balance reduction
Monthly payments throughout plan No monthly payments

Key Takeaways

  • Chapter 13 bankruptcy is a plan that allows an individual or sole proprietor to reorganize and pay is debts without liquidating assets.
  • Debtors must meet certain criteria to qualify for Chapter 13 instead of Chapter 7.
  • Debtors who qualify will be put on a three- or five-year payment plan to discharge their debts.
  • As long as they stick with the plan and meet other debt obligations, such as current mortgage payments, they will be protected from foreclosure and other asset liquidation.

Article Sources

  1. United States Courts. "Chapter 13 — Bankruptcy Basics." Accessed July 30, 2020.

  2. Experian. "What Is Chapter 7 Bankruptcy?" Accessed July 30, 2020.