When you think of bankruptcy, you may think of someone losing everything - their home, their car and far more. Bankruptcy is, after all, a last resort when you've exhausted all options and simply cannot pay for any of their debts.
However, while all bankruptcies can be quite difficult and draining on people, not all of them are the same. Plans can differ from one chapter of bankruptcy to the next. And Chapter 13 bankruptcy is one of the types geared toward individuals and families as opposed to businesses.
Chapter 13 bankruptcy can only be declared if one meets certain criteria. So what is Chapter 13 bankruptcy, how do you repay your debts and what are the advantages and disadvantages?
What Is Chapter 13 Bankruptcy?
Chapter 13 is a form of bankruptcy in which a debtor's finances are reorganized and a plan is developed for the debtor to repay their loans in a set period of time. It is the second most common bankruptcy, behind only Chapter 7.
Chapter 13 is sometimes referred to as Wage Earner's Bankruptcy, as regular income is required for anyone looking to declare. You'll need to show you have a consistent wage coming in, as well as providing updated tax returns.
If you can show definitive proof that you earn a steady wage, you'll also need to make sure the amount of debt you have fits into the required debt window. The unsecured debt that you have (this includes credit card debt and student loan debt) cannot exceed more than $394,725, while your secured debt (such as a mortgage or car loan - something that is tied to a physical asset) can't be more than $1,184,200.
You will also, as with any form of bankruptcy, be required to take credit counseling classes prior to declaring, as well as debtor education courses after. Providing proof that you completed these courses is imperative to getting your debt discharged.
The Chapter 13 method of restructuring debts and creating monthly payments over a set period of time is similar to Chapter 11 bankruptcy, with the crucial difference being that Chapter 11 is for businesses.
Chapter 13 Bankruptcy vs. Chapter 7 Bankruptcy
If Chapter 7, as previously mentioned, is the most common form of bankruptcy for individuals, what separates Chapter 7 and Chapter 13?
In addition to the income requirements Chapter 13 has that Chapter 7 does not, as well as the limits to secured and unsecured debts, the most important difference between the two is that Chapter 7 bankruptcy allows for the possibility of liquidating assets to help pay off the debts. Chapter 13 does not liquidate these assets.
This is crucial if you are a family with income that qualifies you for Chapter 13 bankruptcy and are looking to avoid losing your home. With Chapter 7, your home, car, and other assets tied to your debts can be liquidated. If your house is in danger of being foreclosed upon but you can prove a steady source of income, once you've filed for Chapter 13 that foreclosure attempt ceases. Say a family of four is behind on their mortgage and auto loan because one parent was laid off, leaving the family with just the other parent's lesser income. If this goes on long enough they may be forced to declare bankruptcy, but if they can prove that one source of income is still there, they can keep the family house as they begin work on a plan to pay back restructured debt.
Because assets aren't getting liquidated to help discharge debt in Chapter 13, it also tends to be a much longer process than Chapter 7, as a plan is created to pay off debts over a period of several years.
Chapter 13 Repayment Plan
So how does this repayment plan work, and how does it get started?
Once you've taken credit counseling classes you can submit a petition to file for bankruptcy. If that petition is successful, your case is given to a trustee who will oversee the case.
Because your major assets aren't getting liquidated, at this point you, the debtor, are tasked with developing the monthly payment plan you will have for three to five years, a payment that the trustee will receive and then give to the appropriate creditors that are owed.
This plan will need to be approved by the bankruptcy court, and must be made in good faith. You will be giving your trustee financial records, proof of income and information on the creditors to whom you owe debts. They will also set up a meeting in which you will have to testify under oath about your debt.
Your trustee knows how much you receive in income and how much you owe in expenses. What's left of your income after that, often known as "disposable income," is what will need to go toward most of your monthly debt payments on unsecured debts.
Priority debts, such as overdue alimony or child support payments, are required to be paid in full. Your plan should also prove a realistic ability for you to pay back what you owe in unpaid secured debts like your mortgage.
Throughout the duration of your plan, you are also not allowed to incur any further debts.
Pros and Cons of Chapter 13 Bankruptcy
Is declaring Chapter 13 worth it for you and your finances? It all depends. No form of bankruptcy is all good, after all.
The biggest pro in Chapter 13 is, of course, that you and your family get to keep the house and prevent foreclosure. Chapter 13 may also be able to prevent co-signers on your loan from creditors trying to collect from them.
Some elements of Chapter 13 can be either a pro or a con depending on your situation and outlook. The three to five years you'll be spending making payments may feel like a lengthy period of stress. That length of time, however, may also be able to give you a more realistic chance of getting your payments successfully made on time, giving you the opportunity to have your debts discharged at the end.
One particularly prominent detriment to Chapter 13 (any bankruptcy, really) is that it demolishes your credit score for a while, even if you make all your payments on time. There's a chance it could be on your credit report for up to 10 years.
Ultimately, though, the biggest con of Chapter 13 is the situation that put you in a position to need it. Chapter 13 may be a better position than Chapter 7 because you have income, but keeping that income source is no guarantee. Three to five years is a long time. Jobs can be lost, and periods of unemployment could be longer than you thought. Accidents can happen, and if medical bills can ruin the finances of people in better situations than your own, imagine what it could do to you during bankruptcy.
Chapter 13 may not be the most last resort bankruptcy option, but it's close. Give it a considerable amount of thought and don't go into it recklessly. And if at all possible, you should file and prepare a plan with the help of an attorney.