What is Chapter 13 Bankruptcy?

Chapter 13 bankruptcy allows qualified debtors to pay upon their debts without losing any of their assets, such as their house or car. You may have heard it referred to as the wage earner’s plan. This is because in order to qualify you must have a source of steady income. If you don’t qualify for Chapter 13 you may qualify for Chapter 11 bankruptcy.

Are you considering filing for bankruptcy? Here’s what you need to know about Chapter 13.

Types of Debt Discharged with Chapter 13

Chapter 13 discharges what is referred to as nonpriority unsecured debts. In plain English, this means that Chapter 13 can erase the following types of debts:

  • Medical Debt
  • Credit Card Debt
  • Breach of Contract or Negligence Debt
  • Unsecured Personal Loans (home loans and car loans do not apply, but things like payday loans do)

How Chapter 13 Works

Assuming you have a steady job and are able to make payments, you must first file for Chapter 13. If your case is approved, you’ll make payments for a set amount of time (either three or five years). After those years have elapsed, your debt is discharged. 

How is The Repayment Plan Determined?

The length of the repayment period is not determined by the severity of your debt. It’s determined by how much you make. If you make more than the median level in your state, you must repay upon your debts for 60 months; however, if you make less than the average, you only have to pay upon them for 36 months.  

How Long Does it Take to File for Chapter 13?

For most people, filing for Chapter 13 bankruptcy takes 95 days. This amount of time includes the time it takes to file and the time it takes for the court to approve of the repayment plan. Your debts are not discharged, however, after 95 days. You must first pay upon them for the length of time the court has ordered. That means your debts will actually be discharged after either three or five years of successful payments.

Should You Hire an Attorney?

Hiring an attorney any time you must appear in court for anything other than a minor traffic violation is usually a good idea. It’s especially a good idea when filing for Chapter 13 because of all of the paperwork you must submit. 

Some of the paperwork your attorney must prepare includes:

  • Tax returns
  • Income evidence
  • Description of your living expenses
  • A detailed list of all property in your name, such as your house and vehicle
  • A list of every creditor to whom you owe money
  • A certificate of completion for proving you took an approved credit counseling course
  • Repayment plan

What is The Repayment Plan and How Does It Work?

The repayment plan is a detailed report of how you plan to pay upon your monthly debts. It’s established by filling out a form that describes:

  • How much you make each month 
  • How much you’ll pay the trustee
  • How much the trustee will pay your creditors
  • How long you will make payments to the trustee

Your repayment plan outlines your priority debts (debts that must be paid off), your secured debts ( such as home and auto loans) , and your unsecured debts. It is your unsecured debts that you’ll try to negotiate. You still make payments on your unsecured debts, but they’ll only amount to a portion of what they once were. 

How to File for Chapter 13

There are various steps you must complete in order to successfully file for Chapter 13 bankruptcy. They are: 

Step 1: Take a Credit Counseling Course

Before you can file for Chapter 13, you must first take a credit counseling course from an approved agency no more than 180 days before you file. 

Step 2: File a Bankruptcy Petition

To file a petition, you must pay $310 to your local bankruptcy court. When you do this, you’ll get a reprieve on all of your monthly debts. If you’re going through foreclosure, all proceedings will temporarily stop. Debt collection attempts will also stop during this time. 

Step 3: Submit a Repayment Plan to the Courts

With your attorney, you must provide a detailed plan of how you’ll repay your creditors. It must be submitted no more than 14 days after you have filed your petition for Chapter 13 bankruptcy.

Step 4: Start Making Payments

Regardless of whether or not the court has approved your plan, you must start making those payments you proposed. You must do so within 30 days of your filing for Chapter 13 or the courts may not approve your for bankruptcy.

Step 5: A Trustee is Assigned to Your Case

The courts then assign you a trustee to review your petition who will also speak to each of your creditors. After three or more weeks, you’ll meet personally with the trustee and answer questions under oath about both your debt and repayment plan.

Step 6: Attend a Confirmation Hearing

Next, a judge will decide upon your bid for Chapter 13 and either approve or decline your request. If the judge simply has issues with your repayment plan, you can try changing it to get approval. That said, another option would be to switch tactics and instead file for Chapter 7 (more on Chapter 7 below).

If approved, the repayment term will be established based on your income. You’ll either make payments for three years or five years.

Step 7: If Approved, You Must Continue Making Monthly Payments

Your monthly payments must be as outlined in your repayment plan. Instead of sending the payments to your creditors yourself, however, you’ll instead submit your payment directly to the trustee with whom you met in step five. The trustee, in turn, distributes the allocated amount to each of your creditors on your behalf.   

After you have made payments for either three or five years, your debt will be discharged.

Disadvantages of Filing Chapter 13

Though getting your debt discharged while keeping your assets sounds like a win-win, there are actually a few reasons not to file for Chapter 13 if at all possible.

You Could Still Lose Everything

If you fail to make a single payment, you could lose out on all of the work and money you’ve put into your repayment plan. It’s not automatic, but many people have lost all progress because they missed a payment. Should this happen to you, your bankruptcy case may be dismissed, and all of your assets may be put into danger.  

Qualifying for New Credit Will Be Very Hard

Because you will have a bankruptcy ruling on your credit report, your credit score will take a severe blow. However, it will only stay on your credit report for seven years, meaning after seven years, it will no longer appear.

Because bankruptcy will be on your credit report, very few creditors will want to lend to you because you’ll simply pose too much of a risk to them. If you do qualify, you’ll pay enormous interest rates.

How much your score drops depends on how high your credit score is before you file. Generally speaking, the higher it is, the lower it will fall. A drop between 130 and 200 points is the average most people lose after filing for Chapter 13 bankruptcy.

Chapter 13 versus Chapter 7 Bankruptcy

Chapter 7, as opposed to Chapter 13, erases your debts right after the court ruling. This means that if you’re having trouble paying upon credit cards or loans, Chapter 7 will effectively get rid of them. This is in contrast to Chapter 13. With Chapter 13, you still have to make payments for a certain amount of time. Only after you have successfully made those payments will the debts be forgiven or discharged. 

Chapter 7 is, therefore, best suited for people with an extremely limited income. Though it may sound better than Chapter 13, it’s not. 

With Chapter 7, you could potentially lose:

  • Your house
  • Your car
  • Most of your possessions

There are limitations, of course, to how much of your property can be taken from you. Generally speaking, most material possessions that you think of as yours will be sold to pay upon your debts. 

Does Chapter 7 Affect Your Credit Score Like Chapter 13?

Actually, it’s even worse. With Chapter 13, your credit report is only affected for seven years. With Chapter 7, it’s affected for ten years. 

Are All Debts Forgiven Under Chapter 7?

No. Student loans, unpaid taxes, and alimony and child support are not erased.

The Bottom Line

Speak with a lawyer before moving forward with anything. A seasoned bankruptcy lawyer will likely be able to tell you from looking at your finances whether your bankruptcy case would be dismissed or approved. Just remember that even if you do qualify, there are consequences to filing for Chapter 13. Make sure it’s something that you really want and that would improve the quality of your life. If you’re on the fence, it may not be the right thing to do at this particular moment in your life.