The Kinds of Debts Better Handled through Chapter 13

Posted by Kevin on November 21, 2012 under Bankruptcy Blog | Be the First to Comment

As we said in the prior blog, more complicated debts are usually handled better in the Chapter 13 context.

More complicated debts include those that 1) are not discharged (written-off) in bankruptcy or in a Chapter 7, 2) are in arrears but are secured by collateral you need to keep, and/or where the debtor has significant equity, or 3) are special situations under the Code.

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Debts Not Discharged in Bankruptcy

If you owe a not-so-large recent income tax debt, or are just a little behind on your support payments, you can file a Chapter 7 case and often be able to take care of the tax or support obligation by arranging for monthly installment or catch-up payments. Using Chapter 13 in that situation would likely be unnecessary.

But if the amount you owe or are behind on is too large, or if the creditor refuses to deal, then Chapter 13 would be better. Why? Because it forces the creditor to be lots more patient. It generally gives you up to five years to pay off or catch up on these kinds of debts.

Secured Debt, Lots of Equity

This is truly tricky.  Remember, if the property has significant equity, the trustee may sell the property.  If you want to keep the property, you will have a problem in Chapter 7.  In fact, your only recourse is to make a deal by buying out the trustee’s interest.  If this turns out to be too expensive, you may be SOL.

What about Chapter 13?  Assuming you meet the debt ceiling, Chapter 13 can theoretically help.  What does that mean?  To get your Chapter 13 plan approved by the court, it has to pay out to unsecured creditors as much or more than they would have received in a Chapter 7.  So, if you have $50,000 equity in the property after the liquidation analysis, that means that your creditors in a Chapter 13 will have to get at least $50,000.  Over 3 years that is $16K+ per year, over 5 years-$10K per year.  That’s a big nut to meet every month.  So, Chapter 13, in theory, may help you, but , in reality, may be too expensive.

Secured Debts Where You Are Behind

If you want to hang onto your vehicle and/or home but you’re not current on the loan, Chapter 13 allows you to spread out the arrearages for up to the term of the plan.   If an aggressive creditor objects, so what.  You only need the Judge to confirm the plan.

Special Debts Handled Better in Chapter 13

Chapter 13 has some other features which simply are not provided in Chapter 7, much less provided outside bankruptcy.

Under certain circumstances you can “strip” your second mortgage from your home’s title, so that you pay little or nothing on that second mortgage. This can save a homeowner tens of thousands of dollars, and greatly reduce the monthly cost of the home. In New Jersey, stripping a second mortgage is only potentially available in Chapter 13, not in Chapter 7.

A vehicle “cram down”—in which the amount you owe on your vehicle is essentially reduced to the value of vehicle—is also potentially available only in Chapter 13, not Chapter 7.

If you owe any co-signed debts, they can be favored under Chapter 13 while your co-signer is protected. In contrast, in a Chapter 7 case the creditor would likely be able to pursue your co-signer.

The Limits of a Rule of Thumb

Once again, there’s so much more to deciding between Chapter 7 and 13 than looking at what kind of debts you have and whether those debts are “simple” or “complicated.” There are many other factors, and people so often have unusual combinations of circumstances. This rule of thumb—simple debts lead to Chapter 7, complicated debts lead to Chapter 13—is simply a sensible starting point for your own thinking, and for your conversation with an experienced bankruptcy attorney.