“Converting” Your Chapter 13 Case into a Chapter 7

Posted by Kevin on April 4, 2014 under Bankruptcy Blog | Comments are off for this article

To qualify for Chapter 13, you must be an “individual with regular income, meaning that your income is sufficiently stable and regular to enable you to make payments under a Chapter 13 plan. That requirement of a “stable and regular” income means not only at the time of filing, but for the entire duration of the plan (36 to 60 months).  In a way, every Chapter 13 is a leap in faith that the debtor’s financial situation will be stable (or better) through the duration of the plan.  Of course, life throws you curve balls.  You lose a job, or your hours are cut.  You or a member of your family gets sick and insurance does not cover the whole bill.  The car breaks down-more than once.  Your wife has to quit her job to take care of her sick mother.  Whatever.  The Code takes this into account.  How?   One way  is by allowing you to convert your Chapter 13 to a Chapter 7.

Here’s an example to illustrate this.  You own a home and have two mortgages.  You are  $5,000 behind in payments on your first mortgage (balance $250,000) and cannot remember when you last paid the second (balance of $75,000). You owe $25,000 in credit card bills, and another $10,000 in medical expenses that the insurance did not cover.   The home is worth a  less than the first mortgage.  You had been laid off, but got a new job, and are starting to get significant overtime.  But now, almost miraculously the debt collectors are calling again.  You are making enough to take care of that first mortgage, your current expenses, and  if everyone tightens belts,  a little more, say $250 per month.

Chapter 13 may be the answer.  How, you say.  Even if everything goes right, what am I going to do about that second mortgage?  Chapter 13 gives you the power to “strip” the second mortgage; that  is, convert the second mortgage secured debt into unsecured debt.  Then, the second mortgage gets paid pro rata with the credit cards and medical bills.  How much?  What ever is left over after paying your current monthly bills, your first mortgage arrearages, and the fee to your lawyer and the trustee.  Could be very little.  Plus the “second mortgage strip” also lowers the debt against the home by the amount of that second mortgage, bringing the debt down closer to the home’s market value.  Seems to satisfy both your short term and long term goals. Chapter 13 looks good, so you file under that chapter.   You know it is going to be a bit of a stretch, but if the stars line up right, you get to keep your home and discharge your debts.

15 months into the plan, your boss cuts back on most of your overtime.  You can’t even pay the first mortgage  much less the trustee.  If the case is dismissed, there is no more automatic stay so your creditors will come after you because you now have wages that can be garnished.  What to do?

The Bankruptcy Code explicitly states in that a Chapter 13 debtor may convert a case under this chapter to a case under chapter 7 at any time. Any waiver of the right to convert under this subsection is unenforceable.

Not a perfect solution, by any means.  However, better than being thrown to the wolves.  Let’s look at the scenario under the converted Chapter 7.  First, you do not have to make any more payments to the trustee.  That comes out to $3000 per year.  Second, your Chapter 7 case is over in about 3 months and you most probably get a discharge.  That means that you have knocked out all your debts (mortgage, credit card and medical).

BUT, the Code differentiates between the debt and the security for the debt.  The debt is discharged but the security (mortgage) remains on the property.   Unless you can make a deal with the mortgagees, you will probably lose your home.  But you will not owe any deficiency on the first mortgage or anything on the second.  Moreover, you will knock out the credit card and medical debt.

Now, if you work with experienced bankruptcy counsel, he or she will lay out this scenario in a way that you know or should know that you are taking a “shot”  to save your home.  If it works, God bless.  If not, you switch into a 7, get your discharge and move on with your life.

So conversion to Chapter 7 can be a decent result when the goals of Chapter 13 cannot be met, either because of unexpected circumstances or because the debtors took some calculated risks which did not go their way.