Chapter 13: Consolidation of Debts for Individuals
(251)272-9148 – Attorney Judson E Crump
So for people who don’t want to liquidate, what other options do you have?
Well, if you have assets to lose and decent income, you may want to consider settling your debts or fighting them head on. This normally requires you to quit paying and wait for them to charge off your account (typically 90 days after your last payment), and then try to negotiate a lump sum settlement you can afford, or just let them take you to court and fight them for every dime.
But if you cannot get your creditors to work with you, or you have a home that is facing foreclosure, or a car that is about to get repossessed, then you may want to consider Chapter 13.
Chapter 13 is best thought of as a court-supervised debt consolidation plan. As with Chapter 7, you file a gigantic stack of paperwork with the Bankruptcy Court including a list of all your creditors. The minute you file, you are protected by the Automatic Stay – the court Order that protects you and all your property from your creditors.
And just like Chapter 7, you have a mandatory court appearance about a month or so after you file your bankruptcy case. But from there, the two chapters diverge.
The biggest difference is that in Chapter 13, you make payments for a period of up to five years, and only when you’ve completed your payments do you get a discharge (the court order getting rid of all the debts you had when you filed bankruptcy). You do this by filing a “Plan” with the court. The plan dictates how much money you will pay and who will receive the money. The monthly payment amount depends on several factors, most importantly your assets, your income, and the amount and types of debt you have. I have represented clients with payments that range from $80 per month all the way up to $3400 per month.
Ultimately, Chapter 13 almost always costs more than a Chapter 7. The attorney’s fees are higher (because they have to monitor your case for the next 5 years and if your case gets dismissed early, they don’t get paid in full), the Chapter 13 Trustee gets a portion of each monthly payment – usually about 5-9% off the top.
So why would anyone spend more money to lock themselves into a bankruptcy for years to come when they could do a Chapter 7 and be done with it once and for all?
Three main reasons:
- Chapter 13 allows you to cure any default on secured debts. Translation: even if you’re 6 months behind on your auto loan or mortgage payments, you can keep the house or car from being repossessed or foreclosed.
- If you have filed a Chapter 7 case within the past 8 years, you may not qualify for another Chapter 7, but you could possibly qualify for a Chapter 13.
- If you have limited income or are facing a large garnishment, you may not be able to afford the up-front filing fee for Chapter 7, so you can get bankruptcy protection for just the court cost plus credit counseling fees ($310 + $50=$360). Depending on your income, this sort of Chapter 13 can cost as little as $90/month for 3 years.
Some other advantages to Chapter 13 are:
- Discharge of tax debts without having to file an adversary proceeding (which in Chapter 7 requires a lot more lawyering and therefore more lawyer fees)
- Taxes and child support arrearages can be cured, thereby avoiding more unpleasant collection tactics like bank account seizures, garnishments, tax refund intercepts, and jail.
- Extra legal protections for home mortgages. Before they can receive their share of your Chapter 13 payments, the mortgage company must file several documents showing exactly what you owe and itemizing each charge. If your mortgage servicer is charging you bogus fees or not crediting you for payments properly, then the documentation requirements of the bankruptcy process may alert your attorney to the problem.* Furthermore, the new CFPB regulations require mortgage servicers to give you a shot at a loan modification once they get wind of your bankruptcy.
- Mowing down interest rates. Some auto loan interest rates are simply brutal. I’ve seen people come in with title loans for ~ 40% APR. That’s pretty much impossible to ever pay back. In bankruptcy, creditors don’t get away with God-awful crap like that. Unless you stroll straight from the loan shop into bankruptcy court, you can cut the interest rate down to a single-digit APR.
- Get out from underwater loans (except your home mortgage and cars bought within the past 2.5 years). As with high interest rates, you don’t have to pay off all secured debts for the full balances of their loans – just what the property is worth. This can save you serious cash if you are upside-down on your vehicles.
Some disadvantage of Chapter 13 are:
- You’re stuck in Bankruptcy for 3 to 5 years. It’s kinda like financial prison. Or probation, more accurately. Part 3 of the Bankruptcy Code has a fairly long list of “Stuff You Can’t Do” while in bankruptcy without court permission. Among them: getting a loan, selling assets, modifying a mortgage, getting a divorce, entering a settlement with someone you’ve sued, etc. These things can be done, they just all require a formal, written request to the court and a hearing. Which is a pain.
- The Chapter 13 Trustee wants to take all your money. If you get a raise and the Trustee hears about it, he’ll move to increase your payment. If you get in a car wreck and receive $50,000 for your medical bills, they’ll try to take it. If you inherit 1/4 of your grandmother’s farm, they’ll try to get you to sell it and give them the money. This isn’t because the Trustee is a bad guy. In fact, our local Trustee, Daniel O’Brien, is a really, really nice guy. But his job is to make sure that your unsecured creditors get as much money as you can give them. And that’s what he is going to do.
- Your credit is in limbo for years. It’s no secret that bankruptcy has a negative impact on your credit. But ironically, people who file Chapter 7 usually can repair their credit more quickly than those that hang in there trying to pay off part of their debts via Chapter 13. Why? Because Chapter 13 doesn’t give you a discharge until you’ve paid all your payments, which is usually 5 years after you file. Until then, your debts are basically in a sort of legal version of Schrodinger’s Cat. If you complete the plan, then they’re discharged, but if you don’t, then they fall right back down on you.
- It has more transaction costs. Higher attorney’s fees and Trustee fees mean that only a portion of each dollar you pay in Chapter 13 actually goes towards your debt. The benefits described above can more than outweigh these costs, but you should know that they exist.
*Of course, your attorney may not have enough legal expertise to tell whether a mortgage claim is right or wrong, or your attorney may not give a rat’s ass, but that is a different matter.