Chapter 13 bankruptcy is a legal process that restructures your debt and can, potentially, save your home from foreclosure. Your slate won’t be wiped clean, rather it is designed for individuals who can use continued income to pay off some debts.
Often referred to as “wage earner’s bankruptcy,” the Administrative Office of the U.S. Courts, reports that Chapter 13 bankruptcies were up by more than 26% in 2022 even as total bankruptcies declined by 11.7%.
What is Chapter 13 bankruptcy?
In Chapter 13 bankruptcy, a debtor proposes a three-to-five-year repayment plan.
“It allows debtors to keep most of their assets, while still discharging some of their debts,” said Shmuel Shavowitz, chief lending officer at Approved Funding in River Edge, N.J. “It can also help debtors avoid foreclosure or repossession of their assets.”
Unsecured debts, like credit card bills, may be discharged. For the debt that isn’t discharged, you must make monthly payments.
An impartial trustee, usually a lawyer, is appointed to oversee your Chapter 13 bankruptcy process and collect a monthly payment, dispersing it to your creditors during the repayment period.
“Chapter 13 helps you catch up on secured debts like mortgages and car payments,” said Derek Jacques, consumer bankruptcy attorney with The Mitten Law Firm in Southgate, Mi. “Chapter 7 bankruptcy, by contrast, liquidates your assets to help discharge unsecured debts.”
You can get a bit of a fresh start and stop debt collectors from contacting you.
Pros and cons of Chapter 13 bankruptcy
Like any finance-related tool or process, Chapter 13 has its upsides and downsides.
Pros:
- Allows filers to keep some assets and property.
- Allows filers to restructure their debt payments.
- Possibly eliminates unsecured debts.
- Can help filers get relief from creditors.
- Can help save a home from foreclosure.
Cons:
- Does not eliminate all debts—the filer must repay some.
- Typically requires a lawyer.
- Is often more expensive than Chapter 7 bankruptcy.
- Like all bankruptcies, it’ll affect a filer’s credit score.
- Tax refunds may be used to reduce debt.
Reasons to file Chapter 13 bankruptcy
Under U.S. law, anyone may seek protection from creditors under Chapter 13, including traditional (salary and wage) employees and self-employed individuals. Companies and partnership entities, however, cannot seek relief via Chapter 13 bankruptcy.
Chapter 13 comes with debt limits, as well. Only U.S. adults with unsecured debts of less than $465,275 and secured debts of less than $1,395,875 can seek protection by Chapter 13.
Who would be most likely to file for Chapter 13 bankruptcy?
“Filing Chapter 13 bankruptcy may make sense for those that are trying to save their homes from entering into foreclosure,” Jacques said. “It also helps those that may have income that is too high to qualify for a Chapter 7 filing, but need the relief bankruptcy can provide.”
Other reasons to file for Chapter 13 bankruptcy include:
Keep ownership of assets, including cars. Chapter 13 bankruptcy enables you to satisfy and clear your debts without requiring that most of your assets be liquidated.
Lower interest rates. “In a Chapter 13 bankruptcy, interest rates are typically lowered,” said Mark Pacitti, CEO and founder at Woozle Research in London. Paying less in interest means more goes to what you owe, not to the creditor’s profit margin and you can pay off debt more quickly. Here’s how to lower your credit card interest rates without needing bankruptcy.
Reduce payments. Under Chapter 13, you reduce or restructure your payment plans so that you can feasibly repay them, given your income and other obligations.
Gain creditor protection. A debtor’s creditors cannot take any further legal action against them during the repayment period. “Any remaining unsecured debt may be discharged once all payments have been made,” Pacitti said.
Want to lower your credit card interest rates without going into bankruptcy? Here’s how.
Chapter 13 and personal credit
There’s no getting around the fact that filing for Chapter 13 bankruptcy will negatively impact your credit score, as will any type of bankruptcy.
“It will remain on your credit report for up to seven years, which can make it difficult to get approved for new lines of credit,” Shavowitz said.
Your credit score can drop by hundreds of points, depending on where it was prior to the bankruptcy proceedings.
There is some upside, however.
Since Chapter 13 is designed to help people get themselves out of debt in three-to-five years, you’ll have time to get your credit health back in good shape. (Whereas Chapter 7 bankruptcy liquidates assets in four-to-six months.)
The road back to good credit is slow, and requires discipline.
“To rebuild your credit score, you’ll need to make all of your payments on time and maintain low balances on any credit cards or loans you may have,” Shavowitz said. “It’s also important to make sure you’re not taking out any new debt.”
Filing for Chapter 13 bankruptcy
When you’re considering bankruptcy, step one is to determine whether Chapter 13 is the right move for you. Before filing, look into other options, like a debt management program, which could help you manage your debt without resorting to bankruptcy.
If things are severe and bankruptcy is the best option, check the requirements for the different types. To qualify for Chapter 13, you must have a total debt of less than $2,750,000.
In the bankruptcy process, the court will examine your debts, establish priority payments, determine what payments can be made and, in some cases, decide what debts can be reduced or eliminated (a process called “debt discharge”).
To start off:
- Get a solid bankruptcy attorney. You’ll need an experienced attorney in your state who knows the ins-and-outs of Chapter 13 bankruptcy law.
- Attend credit counseling. You can’t apply for Chapter 13 until you’ve completed an approved credit counseling course 180 days prior to filing for bankruptcy. The bankruptcy court will ask for a confirmed certificate showing you passed the course.
- Get your paperwork in order. Prepare your financial documents, including your tax returns, W-2 statements, banking statements, brokerage statements and a current credit report. The United States Court website offers the needed bankruptcy documents.
- Petition for bankruptcy. With the help of your attorney, file a Chapter 13 bankruptcy petition in the correct Federal Court. Be prepared to pay a $235 case filing fee and $75 administrative fee. At this stage, an impartial trustee is appointed to you.
- Create a plan to pay off your debts. After filing, you have 14 days to submit a repayment plan to the bankruptcy court. A financial advisor can help you create one. You must follow a pecking order when paying debts. Tax debts, for example, are first in line. Then come secured debts, like auto loans and mortgage loans. Last in line are unsecured debts like credit cards.
- Meet with your creditors. Several weeks (21 to 50 days) after you file for Chapter 13 bankruptcy, your trustee will arrange a meeting with your creditors. Attend the meeting and be prepared to testify under oath. If your creditors balk at the deal, you may have to adjust your bankruptcy plan accordingly.
- Start making payments. Even though things are not set in stone, you must start making payments within 30 days after filing for bankruptcy, following the repayment plan. You provide the funds to the trustee who disperses it to the creditors.
- Attend your hearing. No later than 45 days after the creditor call, you’ll be given a date to appear in bankruptcy court. At the hearing, your repayment plan may be confirmed, modified or dismissed. If confirmed (or modified and then confirmed), you’ve successfully been cleared for Chapter 13.
At this point, the trustee takes the reins. You must continue to follow the repayment plan and submit full payments on time to the trustee. You can do this directly or via payroll deduction, which may be easier.
You can’t take on new debt during the repayment period and, if you fail to meet your obligations, the court may do one of two things: Either it can dismiss the case, leaving you back at square one, or it may convert it into a Chapter 7 bankruptcy and liquidate your assets to pay your debts.
If everything goes well and the court determines your debt obligations are satisfied at the end of the repayment period, you’ll have completed Chapter 13 bankruptcy.
Managing your money after Chapter 13 bankruptcy
The challenging experience of going through Chapter 13 bankruptcy highlights the need to develop solid money management skills.
“Managing your budget after bankruptcy can be challenging, but it is possible,” Shavowitz said. “It’s important to start by understanding your current financial situation and creating a budget that lasts.”
Experts recommend that you prioritize your debt payments and establish a separate savings account for emergencies.
There are plenty of resources that can help do so, including budget apps. Personal financial advisors are also an option. One can coach you given the particulars of your circumstance.
“Be mindful of your spending habits and look for ways to save money,” Shavowitz said. “Cutting back on unnecessary expenses, such as dining out, entertainment, and shopping, can go a long way.”
After all, a 2023 economic recession might be coming down the pipe, eventually.
Frequently asked questions (FAQs)
It takes approximately three-to-five years to successfully discharge a Chapter 13 bankruptcy.
A Chapter 13 bankruptcy can be worth it as it can allow you to retain some assets and deal with debt proactively. Ultimately, a successful outcome depends on whether the court approves the petition and whether you fully commit to and complete the process, using the time to pay down all debts.
This depends on your unique situation. Typically, Americans with the deepest debt issues opt for Chapter 7 bankruptcy and have many of their assets liquidated to get the job done. If you have less serious financial debt, Chapter 13 may serve you better and allow you to retain assets.
