The American Dream means something different to everyone you talk to, but the American reality is consumer debt is on the rise, and that debt impacts the American Dream in a significant way. As of May 2017, American consumers are buried under the weight of $764 billion in credit card debt, $8.63 trillion in mortgage debt, and $1.16 trillion in auto loan debt. These are high numbers that make it easy for consumers to get into debt they can't pay off, and they don't even touch on the trillion dollar student loan crisis.
If you find yourself in this situation, buried under a mountain of debt you can't pay off, you do have options. One of those options might be a Chapter 13 bankruptcy. There are pros and cons to filing for bankruptcy, and it's important to understand how filing will impact you. It's also important to understand that bankruptcy should be a last-ditch effort because there are long-term affects to your credit when you file bankruptcy.
If you've exhausted all other possibilities, then you might want to consider bankruptcy as an option. The first step is learning the basics of a Chapter 13 bankruptcy.
Chapter 13 Defined
Chapter 13 bankruptcy is a legal process that allows you to keep your property and repay your debts over a three to five-year period. At the end of that repayment period, any remaining unsecured debts may be discharged.
To be eligible for a Chapter 13 bankruptcy, you must have sufficient income to meet your repayment obligations, and you must have paid your tax returns for the last four years. If your income is too low, or too infrequent, the courts may not approve your petition. If you have income and you paid your taxes, the next consideration is the total amount of your debt. The courts look at both your secured and unsecured debt, and there are limits to both. A Chapter 13 filing cannot have unsecured debt of more than $394,725 or secured debt of more than $1,184,200 (as of April 2016).
For clarification purposes, secured debt has collateral a creditor can take to satisfy the financial obligation in the event you do not pay. This includes debts such as a mortgage or car. Unsecured debt, often considered riskier debt, does not have collateral. If you do not pay this debt, the creditor takes a loss.
There are two types of people who need a Chapter 13, and should probably discuss their options with an attorney as soon as possible. The first are those people facing foreclosure, and the second are those who are above the means test.
A Chapter 13 bankruptcy provides immediate protection from home foreclosure, even if a sheriff's sale has already been scheduled. If you're facing foreclosure, filing a Chapter 13 forces lenders to stay their actions, and it can stop a sheriff's sale, even on the day of the auction. This provides you time to make payments or arrange for a short sale until your repayment plan is sorted out. As an added bonus, any creditors who are harassing you must stop calling once the Chapter 13 is filed.
Also under foreclosure is the benefit of lien stripping. If you have a second or third mortgage or lien against your home, a Chapter 13 bankruptcy can strip the liens from the property and convert them to unsecured debt, which may be eligible for discharge at the end of the bankruptcy. Your attorney must file a special motion with the court at the beginning of the proceedings, but it's an option that could potentially save you money and allow you to keep your home.
In 2005, Congress overhauled the bankruptcy laws and introduced the means test as a form of eligibility. The test is designed to weed out abusive filings, or those the courts determine can be managed reasonably without a bankruptcy. The means test looks at your income, and if it is higher than the median income for your state, then you are not eligible for a Chapter 7 bankruptcy.
However, since Chapter 13 relies on your income to repay the debt, the means test is not a determining factor for eligibility. The introduction of the means test disqualified people with higher incomes from Chapter 7, but allowed them to file for a Chapter 13 provided they meet the other eligibility requirements. Although it is not a requirement for eligibility, the means test is used in a Chapter 13 to determine your monthly payment. We'll look more at payments in a future section of this guide.
Chapter 13 Process
The process for filing a Chapter 13 starts with your attorney. You meet with the attorney to discuss your situation, and he or she will tell you whether you qualify, and if they think it's the right move for you. If it is, then you will be given a packet of forms to fill out with explicit instructions on your next steps.
First, you'll have to create a budget. This is used to help determine your payment, and it shows the courts you have financial responsibility. Next, you'll have to obtain copies of your tax returns for the last four years and copies of your credit reports for the file. Once you've filled out the paperwork and gathered the required documentation, you have to take a credit counseling course from an agency approved by your state's trustee. The agency may charge a fee, but they are required to provide the counseling for free or at reduced rates if you cannot afford to pay.
Chapter 13 Repayment Plan
Part of your paperwork packet is the repayment plan. This document describes your repayment plan in detail, including how much you owe each creditor, how much you will pay each creditor, and in the case of unsecured debt, how much of the debt will be discharged at the end of your three to five-year plan.
Priority Debts vs. Non-Priority Debts
During a Chapter 13, there are certain debts that must be paid in full by the end of the plan, and then there are debts that will be discharged at the end, much like a Chapter 7.
Priority debts are deemed important enough to be paid in full, and the bulk of your payments each month will go toward these payments. Priority debts include child support and alimony, certain tax obligations, attorney fees, and trustee fees.
The next in line include your secured debts such as mortgages and auto loans. In addition to continued payment on these debts, a bankruptcy also includes repayment on any past due payments to catch you up. At the end of your bankruptcy, you may continue to pay your creditors as normal. There are certain details and requirements you may need to meet, so it is important to ask your attorney about them during your assessment meeting.
Finally, you have your non-priority debts which include unsecured debt such as credit cards. Your repayment plan will take up quite a bit of your disposable income to pay off as much of your debt as possible, even the unsecured debt. However, because the unsecured debt is not a priority, it will not receive the bulk share of your payment. That means you may have some unsecured debt left over at the end of your bankruptcy. The courts may discharge the debt, and you will no longer owe those creditors money.
A quick note about student loans: you can include them in a Chapter 13 bankruptcy, but they cannot be discharged at the end of your plan. For repayment purposes, student loans are considered a priority debt, and they will receive a large chunk of your payment; however, it is unlikely they will be paid in full before the end of the plan.
Student loan creditors must follow the same rules as other creditors, meaning a stay of execution is submitted, and they can no longer contact you about delinquent payments. But, at the end of the payment plan, any debt still remaining reverts back to those creditors, and you will still have to deal with them. In addition, interest continues to accrue on those loans and gets added to your payments at the end of your bankruptcy.
Length of a Chapter 13 Repayment Plan
The length of your payment plan is determined by your state's trustee, and it depends on how much you earn and how much you owe. If your monthly income in the six months prior to filing for bankruptcy is over your state's median income, then you'll have to propose a five-year plan. However, if it is below the median income, you can propose a three-year plan. There are exceptions to this, though. A below-median debtor may need to extend their plan to five years to pay a sufficient amount of the debt, while an above-median debtor may be able to pay their plain in full within three years.
What Happens If You Can't Make Payments
Your repayment plan is based on your income, but sometimes your financial situation changes. If you lose your job or become ill, you have a few options:
- Your trustee may let you modify your plan to reduce your payments.
- The court might let you discharge your debts on the basis of hardship.
- You may be able to convert your Chapter 13 to a Chapter 7
- You may have to dismiss your Chapter 13 case, but you would still owe debts plus any interest not charged while held in bankruptcy
If you find yourself in a situation where you cannot make your payments, you should contact your attorney to discuss which option makes the most sense for your circumstances.
Ending a Chapter 13 Case
At the end of your three or five-year plan, any debts eligible for discharge will be wiped out and you will not have to pay them. Student loans revert back to the creditor, and in most cases, your secured debts and child support and/or alimony continue as normal. Before your case can be officially closed, you must show the courts you are current on your child support and/or alimony, and you must complete an approved budget counseling course.
Once you've provided those items to your trustee, your bankruptcy is dismissed, and you're free to rebuild your credit. Just note that a bankruptcy stays on your credit report for up to seven years, and has a significant impact on your credit score for up to five years.
The Law Offices of Matthew T. Desrochers, P.C.
The Law Offices of Matthew T. Desrochers, P.C. has been helping people resolve their debt since 1999. We offer free case evaluations to determine which course of action best suits your needs. Contact us anytime to schedule an evaluation and begin your journey to a debt-free life.