Filing Chapter 13 is a flexible way to pay as much as your budget allows, over a reasonable time, and then write off the rest.
The title of this blog post, and the above sentence, summarize well how this “adjustment of debts” version of bankruptcy works. There are, however, both limitations in what filing Chapter 13 can do, and also some incredibly powerful ways that it can improve your financial life.
How Chapter 13 Works
In a Chapter 13 case, you and your attorney put together a creditor payment plan based mostly on your income and expenses. So in many respects you pay your creditors only as much as you can actually afford to pay them.
You are allowed, indeed required, to favor certain creditors over others, but often those are creditors you would want to pay, like to catch up on a home mortgage arrearage, or to pay recent income taxes that you can’t write off (“discharge”) in bankruptcy. You may well end up paying certain special debts in full while paying others little or nothing, based on bankruptcy laws that you and the creditors must follow.
How long you pay into your plan depends in part on your income, with most people being obligated to pay for 3 years, or for a maximum of 5 years if your income is higher. Sometimes you might want to stretch out the payments longer in order to bring the monthly payment down and still be able to accomplish your financial goals—such as paying off a vehicle or catching up on back child support. But you are not allowed to stretch it any longer than 5 years.
From the moment your Chapter 13 case is filed, and then throughout the 3-to-5-year period, you and your income and your assets are protected from your creditors. This protection—which lasts only three months or so in a Chapter 7 “straight bankruptcy” case—is a crucial part of a Chapter 13 case. It’s what allows you to keep creditors like the IRS or the support enforcement people on hold while you pay other even more important debts ahead of them or only pay them with very small payments over a long span of time.
At the successful end of your Chapter 13 case virtually all your debts are discharged forever. Other than long term debt like a home mortgage or most student loans, you will be debt-free. And you will have in the meantime accomplished some goals that you could never have accomplished otherwise, even under Chapter 7.
The Extraordinary Tools of Chapter 13
This isn’t the place to catalog all the many powerful tools that Chapter 13 provides, but here are a few to give you an idea what it can accomplish:
- A vehicle loan “cramdown” effectively allows you to re-write your loan terms if you’ve had your vehicle for at least 2 and a half years and it’s worth less than the amount you owe. This can significantly reduce your monthly payment, lower your interest rate, and can shave thousands of dollars off what you would pay before the vehicle is yours free and clear of debt.
- The “stripping” of a second or third mortgage allows you to stop making payments on that second/third mortgage and allows you to get rid of that debt for usually pennies on the dollar—if your home is worth less than the amount you owe on debts ahead of that mortgage. This can save you hundreds of dollars a month, and tens or sometimes even hundreds of thousands of dollars over the life of that mortgage.
- If your divorce decree requires you to pay certain marital debts, either to the original creditor or to your ex-spouse (other than for child or spousal support), you can discharge that debt. You only have to pay this, together with all of the rest of your ordinary debts, as much as you can pay them, AFTER other higher creditors are paid. This often leaves you paying only a small percentage of what your divorce decree had obligated you to pay, and then the remaining amount is discharged so that you no longer have to pay it.
The Limitations of Chapter 13
You DO have to follow many rules in a Chapter 13, in putting together the payment plan and as you execute it. For example:
- You MUST pay enough money into your Chapter 13 plan to pay all “priority debts” in full, for example all recent income taxes (those that can’t be discharged) and child and spousal support arrears.
- If you are keeping your home and are behind in payments, you can’t reduce the monthly mortgage payment but must pay the full contractual amount (if it’s not a 2nd or 3rd mortgage that can be “stripped”), and you must catch up on the entire arrearage by the completion of your case.
- When you are using Chapter 13 to catch up on child and spousal support arrearage, you must resume and keep making your ongoing support payments (assuming that you are still obligated to pay them). Otherwise your ex-spouse or support enforcement agency will quickly be able to go back to garnishing wages and using all the other aggressive means of collecting on the back support.
- Whatever debts are not paid through Chapter 13 are discharged only at the successful end of the case. Although there are a variety of options if your circumstances change during the length of a Chapter 13 case, if you and your attorney do not proactively address the situation and you fail to make the monthly plan payments, your case can get dismissed—thrown out. This would leave you suddenly without the ongoing protection from your creditors and without your debts being discharged.
The Bottom Line
If you are facing serious financial challenges, you may well be able to hugely improve your life through a Chapter 13 case. You could improve it immediately, for the medium term, and even potentially for the rest of your life. That’s a New Year’s resolution worth keeping.