Chapter 13 Basics-Why File?

Posted by Kevin on November 3, 2017 under Bankruptcy Blog | Be the First to Comment

In Chapter 7, debtors make no payments to their creditors but a Chapter 7 trustee can sell all non-exempt property and pay unsecured creditors.  The process is over in 4 months or so, and the debtor obtains a discharge of most of her debts.  In Chapter 13, however, debtors get to keep even their non-exempt property but must make monthly payments to the Chapter 13 trustee for a period of 36 to 60 months before they can get a discharge of most of their debts.

So, we are assuming that you are having trouble paying your bills.  You are contemplating bankruptcy.  Why would you choose to make payments for 3 to 5 years to get a discharge when you can pay nothing and get a discharge in 4 months.  Well, there are a number of reasons why prospective debtors pick Chapter 13.  In 2005, Bankruptcy Code was amended by a law referred to as BAPCPA.   BAPCPA adopted what is called the Means Test to determine if you could file under Chapter 7.  If your income based on family size exceeds the median for your State, you must pass the Means Test to file under Chapter 7.  The Means Test is based on IRS tests to determine how much a taxpayer can pay in back taxes.  So, if you are above median income and you fail the Means Test, you cannot file Chapter 7, and are be required to file under Chapter 13 if you otherwise qualify.

But, there are other reasons to file under Chapter 13 even if you pass the Means Test.  Say you own a home with significant equity.  In a Chapter 7, the trustee can sell your home and pay off your creditors.  In a Chapter 13, if you make all payments under a Plan confirmed by the Court, you can keep your home.  In addition, let’s say that you own a home but are in arrears on the mortgage.  In Chapter 13, you can pay off the arrears over the term of the Plan.  That could be up to 60 months.

Finally, say your house was worth $400,000 when you bought it, but after the mortgage crisis, it is only worth $250,000.  You owe $270,000 on a first mortgage and $50,000 on a second mortgage.  In this case, the collateral covers most of the first mortgage, but the second mortgage is completely unsecured.  In other words, if there was a foreclosure, the first mortgage holder would be paid a good amount of what it is owed, but the second mortgage holder would get nothing.  In Chapter 13 in our example, you can “strip off” that second mortgage and treat it as unsecured debt since there is no collateral to attach to that mortgage.  So, instead of making monthly payments of, say, $300 per month on the second, that creditor gets only a pro rata share of what is paid to the unsecured creditors.  If your plan payment is, say, $100 per month, then the second mortgage holder gets to share that $100 with the other unsecured creditors instead of getting $300 per month.  A substantial savings.   If you make all the payments, the second mortgage holder is required to release the mortgage lien of record.

In some cases, you are forced into Chapter 13, but that does not mean that Chapter 13 cannot provide some real benefits, especially to homeowners.  If you think Chapter 13 can help your situation, you should speak with an experienced bankruptcy attorney.  Chapter 13 is not a DIY project.