Why file Chapter 13? Chapter 13 has huge advantages in many situations, often making any extra cost well worthwhile.
We have written several blog posts lately about the advantages of Chapter 13. This touches on the basics, but please read further back into November’s posts for more details.
Sometimes You Pay Nothing to Certain Creditors in a Chapter 13 Case
To start, the assumption in the title to this blog post is inaccurate. True, under all Chapter 13 cases you will pay something to at least some of your creditors, and under most of them you will pay something to all or most of your creditors. But not always.
First, in some Chapter 13 cases you do not have to pay anything to those creditors which would have received nothing in a Chapter 7 case. In situations in which you are paying all you can afford to certain special creditors, you would likely pay little or nothing to the rest of your creditors. Those special creditors are generally ones that you want to or need to pay no matter what, and would do so if you filed a Chapter 7 case, but Chapter 13 lets you do so more easily and safely.
Furthermore, because Chapter 13 has the power to get rid of some debt and liens that Chapter 7 cannot, sometimes you pay less overall to your creditors under Chapter 13 than under Chapter 7.
Second, even if you are scheduled to pay something to all creditors in a Chapter 13 case, you would not have to pay anything to creditors which neglect to formally ask the bankruptcy court to be paid. Generally if a creditor wants to get paid whatever portion of its debt that your Chapter 13 plan says it would be paid, it has to file a simple “proof of claim” with the bankruptcy court. Creditors have a very strict deadline to do so. If any creditors miss that deadline, you usually do not have to pay them anything. The debt is discharged (legally written off) at the successful completion of your Chapter 13 case. This happens surprising often.
You File Under Chapter 13 for Its Advantages or When You Have No Choice
Broadly speaking, you would file a Chapter 13 case for two reasons: because you want the powerful tools that it gives you (and Chapter 7 does not), or because you do not qualify for Chapter 7, so you’re stuck with Chapter 13.
Chapter 13 Advantages
Most of the time people choose Chapter 13 instead of Chapter 7 simply because it is better for them.
Often its most important advantage is with your secured creditors, those with collateral that is precious to you.
With your home, Chapter 13 can enable you to prevent a foreclosure and pay off any arrearage on your mortgage over the course of years, making saving your home possible. It can “strip” second or third mortgages, so you no longer have to pay the monthly mortgage payment (nor need to catch up on any arrearage), and which in effect add tens of thousands of dollars of equity to your home. You can “void” many judgment liens, and deal very favorably with tax and child/spousal support liens, and with just about any other kind of lien on your home.
With your vehicle, you may be able to do a “cramdown,” reducing the monthly payments and often shaving thousands of dollars off how much you need to pay before it’s yours free and clear. With other collateralized debt—secured by furniture, appliances, business equipment and such—a “cramdown” may give you analogous savings. Even if you don’t qualify for “cramdown,” Chapter 13 is usually a more protective and flexible way of keeping collateral.
Chapter 13 also gives you a great way to pay certain creditors that you would still have to pay after completing a Chapter 7 case—such as recent income taxes and support arrearages. But you do so with significant advantages.
With income taxes usually you don’t have to pay ongoing interest and penalties, and you pay it off based on your own budget and often only after paying more urgent creditors. Also, throughout the payback period you are protected from the IRS and/or state tax authorities, and their tax liens, levies, and payment demands.
With child and spousal support arrearages, Chapter 7 provides no help at all. But Chapter 13 can stop the potentially very aggressive collection procedures of ex-spouses and support enforcement agencies, giving you a chance to get current without the threats of garnishment, losing your driver’s license, or even your professional or occupational licenses.
Chapter 13 can also protect your assets which could otherwise be lost to a Chapter 7 trustee. It can protect co-signers. It can also often protect special creditors that you favored before filing bankruptcy—such as the relative or doctor you paid because you felt morally obligated to do so.
Lastly, Chapter 13 can discharge—write off—some debts that Chapter 7 cannot, particularly non-support debts owed to an ex-spouse.
You Don’t Qualify to File Under Chapter 7
The main reasons people would not qualify for Chapter 7, and thus be forced to file a Chapter 13 case instead, are that:
1. their income is too high, or the combination of their income and their allowed expenses gives them too much “disposable income,” so that they do not pass the “means test”; or
2. they filed a prior bankruptcy case too recently, either a Chapter 7 case within less than 8 years or a Chapter 13 case within less than 6 years (under most circumstances), so are legally prohibited from filing and getting a discharge of debts through a Chapter 7 case now.
These are both relatively rare situations. But if you need relief from your creditors and can’t file a Chapter 7 “straight bankruptcy” case, a Chapter 13 “adjustment of debts” is often your best option. That may well be true even if you do have to pay something instead of nothing to your creditors.
Another reason people file Chapter 13 is to protect an asset that would otherwise be seized and sold under Chapter 7. In Chapter 13, assets are not taken by the trustee and sold for your creditors. You pay your creditors, over time, what they would have gotten had that happened.