Chapter 13 Bankruptcy
In these hard economic times more and more people are being faced with the unfortunate necessity of filing bankruptcy. Being faced with this decision is not only emotionally challenging, but can be very confusing as well. You often hear many strange terms and references, like Chapter 13, cramdown, lien strip, or many others. This article is going attempt to eliminate some of the confusion about Chapter 13 bankruptcies and some of these unusual terms that lawyers use.
What is a Chapter 13 Bankruptcy?
The first question to answer is what is a Chapter 13 Bankruptcy. A Chapter 13 Bankruptcy is often referred to as the wage earners bankruptcy. As the name implies it is for individuals or couple who are employed. How this type of bankruptcy works is that the court examines the debtors current income and expenses and helps the debtor develop a repayment plan based on the income and expenses to pay the existing creditors. The payment amount is based on the difference between your income and expenses (not counting your unsecured debt like credit cards). This amount becomes your monthly payment that you will pay to the court. The payment will be used to pay bankruptcy costs and your creditors. The creditors will typically not receive a complete payment, but rather will receive substantially less than they would in a typical liquidation type bankruptcy (Chapter 7). Once you have made your agreed upon payments for the set period of time (three to five years) all of your remaining debt is discharged and you no longer have to pay that debt.
Why would I file a Chapter 13 Bankruptcy?
After reading the explanation about a Chapter 13 bankruptcy I am sure the thought going through your mind is why would I want to file that, it seems complicated. While it is more complicated that a traditional bankruptcy, there are some good reasons why you would file a Chapter 13 Bankruptcy. The four most common are:
1) You Have to
Under the current bankruptcy laws there is an income requirement to be eligible to file a traditional Chapter 7 bankruptcy. If your annual income exceeds two times the poverty level in the area you live you will not be eligible to file a Chapter 7 bankruptcy. In the Phoenix, Arizona area this amount is approximately $42,000 for a single person and goes up if you have additional dependents. This is just an estimate and there are other considerations involved so make sure to do the proper calculations and not simply rely on the estimate provided in this article.
2) You have nonexempt assets you want to keep
In a Chapter 7 bankruptcy all of your nonexempt assets are transferred to the court and those assets are sold to pay your creditors. If you have nonexempt assets that you want to keep you can actually file a Chapter 13 bankruptcy and keep those assets. Your payment plan will have to be structured properly, but it is possible to keep nonexempt assets in a Chapter 13 bankruptcy.
3) You are behind on a mortgage or other secured debt
Another difference between a Chapter 7 and 13 bankruptcy is how the bankruptcy deals with late payments to secured creditors. In a traditional bankruptcy if you are behind on your payments to a secured creditors (such as your mortgage payments) if you want to keep the asset you must immediately get all of the payments caught up. If you do not, the creditor can sell the asset to pay the debt. In a Chapter 13 you do not immediately have to pay the late payments back, but rather the late payments will be paid as part of your payment you make to the bankruptcy court. The entire amount still gets paid, it will just get paid back over the length of you plan, not immediately. You do still need to make your future payments to the creditor outside of the plan.
4) You owe more on assets than they are worth
If you owe more on assets than they are worth a Chapter 13 can provide some additional benefits not available in a traditional bankruptcy, including the ability to remove or reduce liens. On personal property, (most typically cars) the bankruptcy court can reduce the amount of owe as a secured debt on a asset. This is referred to as a cramdown. The best way to explain this is an example: Assume you own a used SUV with a blue book value of $5,000. You owe $10,000 on the car. The bankruptcy court can reduce your secured claim to the $5,000 value of the car and make the other $5,000 an unsecured debt. This distinction is important becomes you must pay the entire secured claim to keep the car, but the unsecured portion doe not need to be paid in full.
There is also a slightly different way the bankruptcy court can deal with lien against real property. The court can not reduce a lien, but the court can completely remove the lien, if the lien is completely unsecured. This is often called lien stripping. Again this can best be seen by an example: Assume you own a house worth $150,000. Your first mortgage is $175,000. You also have a home equity line of credit (a HELOC) that you owe $50,000. The court can not reduce the first mortgage so you must pay all of that mortgage to keep the property. However, the second mortgage is completely unsecured as the value of the home is less than is owed to the first mortgage. The court thus has the ability to strip this lien and make the debt unsecured. This is a difficult process, so make sure you follow all of the procedures if you are attempting on your own or better yet consult an attorney who can assist you with this process.
While this article certainly oversimplified many of the issues involved in a Chapter 13 bankruptcy hopefully it provided some general information to remove some of the anxiety associated with having to file bankruptcy. As always, do not rely solely on the information in this article for your legal advice. Please consult with a qualified attorney before making any decisions about your financial future.