What is Chapter 13 bankruptcy?
Filing for bankruptcy can help you clear out overwhelming debt and press reset on your financial situation. Although bankruptcy does impact your credit, it can also help you avoid foreclosure and gives you breathing room to get a better grip on your finances.
Multiple types of bankruptcy exist. If you have some assets and a regular income, Chapter 13 bankruptcy might be the option that works best for you.
What Is Chapter 13 Bankruptcy?
Chapter 13 bankruptcy is sometimes called a wage earner’s plan, since a steady income is one of the requirements for it. The specifics of the bankruptcy are spelled out in Chapter 13 of the U.S. Bankruptcy Code.
You must file Chapter 13 bankruptcy in federal bankruptcy court. The process is overseen by the court with input from the U.S. Department of Justice.
The goal of a Chapter 13 bankruptcy is to repay your debts, usually over a three to five year period. You create a repayment plan that details how you’ll repay your debts. The court reviews the plan and decides whether to approve it or not.
Your creditors have a say, too. If they don’t like what you’ve proposed, they can object to the court. The court is obliged to listen to your creditors but has the ultimate say in whether your repayment plan is approved or not.
Depending on your situation, your payment plan might have you repay your debts in full or in part.
Chapter 13 bankruptcy isn’t a get out of debt free card. You can’t include every type of debt in your repayment plan. For example, if you’re struggling to repay your student loans, you’ll want to explore other options besides bankruptcy. Bankruptcy doesn’t wipe out student debt.
The same is true for:
If you have a mortgage or car loan and you want to keep the asset, you can continue to make payments on either loan while in the repayment plan. A Chapter 13 repayment plan can also help you get caught up if you’re behind on these types of loan.
Chapter 13 vs. Chapter 7 Bankruptcy
Chapter 13 isn’t the only bankruptcy option out there. Depending on your situation, Chapter 7 bankruptcy might be a better choice.
Chapter 13 is a type of reorganization bankruptcy, while Chapter 7 is a liquidation bankruptcy. If you file Chapter 7, you usually have to sell some assets to pay off your debts.
There are notable differences between Chapter 7 and Chapter 13 bankruptcy.
- Who Can File. Both Chapter 7 and Chapter 13 are open to individuals. Businesses might also file Chapter 7, but can’t file for Chapter 13 bankruptcy. Chapter 11, which is similar to Chapter 13, is another option for businesses.
- Income Requirements. Chapter 7 bankruptcy has income limits for individual filers. You need to have income below a certain threshold or you need to pass a means test, which shows that your disposable income isn’t sufficient to repay your debts. Chapter 13 doesn’t have a means test but does require you to have a source of income.
- Debt Limits. According to the Bankruptcy Code, you can file Chapter 13 only if your unsecured debts are less than $394,725 and your secured debts are less than $1,184,200. These limits may change over time, so refer to the Bankruptcy Code for up-to-date figures.
- What Happens to Your Property. If you file Chapter 7, you usually have to sell assets and property to pay off your debts, with the exception of your primary home, car, and other essential items. You can also keep your home and other property if you file Chapter 13, since you’re making a plan to repay your debts.
- How Long the Process Takes. Chapter 7 typically takes a lot less time than Chapter 13. Once everything’s liquidated, it’s over. Usually, that’s after a few months. Chapter 13 can take as long as five years, depending on your payment plan.
- Impact on Your Credit. A Chapter 7 bankruptcy stays on your credit report for 10 years. Chapter 13 bankruptcies stick around on your credit report for seven years. In either case, you can start to rebuild your credit after filing bankruptcy.
Chapter 13 vs. Chapter 11 Bankruptcy
Chapter 11 bankruptcy is another type of reorganization bankruptcy. But, unlike Chapter 13, Chapter 11 is usually reserved for big corporations or partnerships. When you hear about a company filing for bankruptcy, but not going out of business, it’s usually filing Chapter 11.
When a corporation files for Chapter 11 bankruptcy, it needs to create a repayment plan and that plan needs to be approved by the bankruptcy court.
You might file for Chapter 11 bankruptcy as an individual if you’re not eligible for either Chapter 7 or Chapter 13. For example, if you have too much debt to file for Chapter 13, Chapter 11 might be your best bet. The same is true if you don’t have a source of income.
Should You File for Chapter 13 Bankruptcy?
Bankruptcy isn’t something you rush into or a decision to take lightly. The process can be complicated and time consuming. It can also do a number on your credit. Some people are better off avoiding it.
But for some people, bankruptcy is the best way to get out of a financial hole and to start the credit rebuilding process. If you’re behind on payments and are struggling to keep afloat, the impact of bankruptcy on your credit score probably won’t be that terrible, as paying late has already damaged your credit.
Whether Chapter 13 is right for you depends on the type of debts you have, your income, and the overall impact on your financial life.
- You Have Regular Income. You need to have regular monthly income to qualify for Chapter 13. If you have income and the difference between your earnings and your obligations isn’t enough, Chapter 13 can help you out.
- You Own a Home and Car. If you’re at risk of foreclosure or are behind on your mortgage or car payments, Chapter 13 gives you an out. You can usually keep your primary home and vehicle — and possibly other vehicles and real estate — under Chapter 13.
- You Have Eligible Unsecured Debts. If you have medical bills, credit card debt, or personal loans, filing Chapter 13 can mean you end up with a more manageable monthly payment.
- You Have Few If Any Priority Debts. Priority claims or debts include alimony, child support, and student loans. Bankruptcy doesn’t eliminate these debts.
- You Can Repay Based on Your Payment Plan. Critically, you need to be able to pay based on the plan the court approves. If you miss payments, the court could dismiss your bankruptcy and force you to sell assets.
- You’re Really Struggling to Make Ends Meet. Think of filing Chapter 13 bankruptcy as pressing a big, red emergency button. It’s not something you press when you’re experiencing a temporary setback or when there are other options to help you pay your debts, such as getting a side hustle or finding ways to trim expenses. Only file for bankruptcy if as a last resort.
Eligibility for Chapter 13 Bankruptcy
You’re eligible for Chapter 13 bankruptcy if you have regular income and your debts aren’t above the limits for unsecured or secured loans. Beyond that, there are additional requirements.
- You Need to Provide Tax Returns. You need to file tax returns and be current on your tax payments.
- You Can’t Have a Recently Dismissed Bankruptcy. You’re not eligible for Chapter 13 bankruptcy if you had another bankruptcy dismissed within 180 days for failure to comply.
- You Can’t Have Recently Filed for Bankruptcy. If you filed for Chapter 13 before, the discharge, or end of the bankruptcy, can’t have been within two years. If you filed for another type of bankruptcy, such as Chapter 7, the discharge can’t have been within the past four years.
- You Need to Complete Credit Counseling. You must complete credit counseling to be eligible for a discharge under Chapter 13.
The Chapter 13 Bankruptcy Process
Once you’ve decided to go forward with Chapter 13, consider hiring a bankruptcy lawyer to help you through the process. There are many steps involved and a lot of paperwork required too. Your attorney ensures you have the documents needed to file and can help speed up bankruptcy proceedings.
The first step is to submit the required documents and forms to the bankruptcy court. You need to give the court the following:
- A list of your assets and debts
- A list of your current income and expenses
- A list of current leases and contracts, such as an apartment lease or cell phone contract
- A statement of your financial affairs
You also need to submit a copy of your most recent tax return, plus any tax returns you filed during the case.
Along with submitting the right forms and information when you file your bankruptcy petition, you also need to pay a case filing fee and a miscellaneous administrative fee. You can pay these in up to four installments, if necessary.
Once you’ve filed your bankruptcy petition, the court appoints someone as your bankruptcy trustee. The trustee is an impartial individual who oversees your case. You make payments to the trustee and they disburse the payments to your creditors.
Filing the petition also creates an automatic stay, meaning your creditors can’t pursue the debts anymore. The stay also applies to any co-signers on your debts.
2. Credit Counseling Course
When you file for bankruptcy, you need to provide the court with evidence that you completed a credit counseling program through an approved agency. The U.S. Department of Justice has a list of approved credit counselors. The credit counseling needs to be within 180 days of your filing.
The goal of counseling is to determine if you earn enough to qualify for Chapter 13. Counseling also verifies that bankruptcy is the right thing to do. If it isn’t, your counselor will point you toward other options, such as cutting expenses or earning more money.
During your counseling, you might work on creating a debt repayment plan with the agency. If that’s the case, you should submit a copy of the repayment plan to the court when you send in your bankruptcy petition.
3. Debt Repayment Plan
You can submit a repayment plan with your bankruptcy filing. If you don’t, you have 14 days after the filing to send one to the court. Under the plan, you make fixed payments to the trustee, the individual assigned by the Justice Department to oversee your case. These payments may be either monthly or biweekly.
Based on the type of debt you have, your plan might include the following claims:
- Priority. Priority debts include federal student loans, child support, alimony, and tax debts. You need to pay these back in full
- Secured. A secured debt is any debt with collateral behind it, such as a mortgage or car loan. If you want to keep the asset connected to the debt, you need to pay the loan back in full. You can continue to make payments on secured debts after the payment plan is over.
- Unsecured. An unsecured debt, such as an unsecured personal loan or credit card, doesn’t have a claim to a specific piece of valuable property. As long as the unsecured creditors get as much as they would have if you liquidated the debt under Chapter 7, your repayment plan doesn’t necessarily have to pay off your unsecured debt in full.
Begin making payments to the trustee based on your repayment plan within 30 days after filing, even if the court hasn’t approved the plan yet.
4. Confirmation Hearing
At least 21 days after filing for bankruptcy, the trustee will call a meeting of the creditors. The meeting gives creditors and the trustee the chance to ask you more about your financial situation and the payment plan. It gives you a chance to work out any issues with the creditors before moving forward.
Within 45 days of the creditors meeting, a confirmation hearing needs to occur. During the hearing, a judge will decide if the plan is feasible and meets the bankruptcy code’s standards. Creditors receive notice of the hearing and can object to the plan’s confirmation.
At the hearing, the judge can do one of three things:
- Confirm the plan
- Request modifications to the plan
- Dismiss the case
If the judge dismisses the case, you remain responsible for any debts. You can refile right away if the case was dismissed without prejudice. If it was dismissed with prejudice, you might have to wait to refile, as specified in the court order. In some cases, the judge might prohibit you from filing again.
After the court confirms the repayment plan, it’s up to you, the debtor, to make payments as outlined. You can pay the trustee directly or set up payroll deductions, whatever is easiest for you.
Failing to make payments can lead to your case being dismissed. The court can also convert the case to a liquidation bankruptcy if you don’t pay according to the plan.
Once you’ve made all the payments, usually within three to five years, your case can be discharged. To be eligible for discharge, you must have completed an approved financial management course and not had another bankruptcy discharge.
After discharge, you’re freed from any further obligations to your unsecured creditors. Chapter 13 bankruptcy discharge won’t wipe away your priority debts or your mortgage or other secured debts.
Chapter 13 bankruptcy isn’t an instant pass to a debt-free life. You’ll need to pay back your creditors based on the repayment plan and you might still have some debt left after your discharge.
But, depending on your financial situation, it could set you on the path to rebuilding your credit score and improving your financial footing.
Before you decide to file for Chapter 13, talk to a credit counselor and a bankruptcy attorney to get familiar with your options and to see what’s best for your circumstances. It’s worth taking a little extra time to get this very important financial decision right.