No one wants to lose property in a Chapter 7 bankruptcy or pay a hefty monthly payment for three to five years in a Chapter 13 case. However, it might not sting quite so much if the funds are used to pay down a debt that you’ll remain responsible for after your bankruptcy is over. To find out which of your debts will be paid first—or at least to get a general idea—you’ll want to review the priority ranking system used by the bankruptcy court.
Who Pays the Creditors?
If money is available to pay creditors (which isn’t always the case), the bankruptcy trustee—the court-appointed official responsible for administering your matter—will distribute the funds according to a priority system outlined in bankruptcy law (more on this below). The way the trustee gets funds to pay creditors depends on the bankruptcy chapter that you file.
Chapter 7 bankruptcy. In this chapter, you’re allowed to “exempt” (keep) a certain amount of property, such as household items, clothing, a modest amount of equity in a car, your retirement account, and possibly a portion (or all) of your home equity. In Chapter 7 bankruptcy, the trustee sells your other property—known as “nonexempt” property—and distributes the proceeds to your creditors.
Chapter 13 bankruptcy. If you file a Chapter 13 case, the trustee doesn’t sell your property. Instead, you pay for the value of your nonexempt property—plus any additional disposable income you might have—in your three- to five-year repayment plan. The trustee will disperse the funds to your creditors on a monthly basis.
(You can learn about property exemptions by reading If You Declare Personal Bankruptcy, What Can You Keep?)
Secured and Unsecured Claims
To get paid, a creditor must submit a proof of claim that sets forth the outstanding amount owed, and whether the claim is secured or unsecured. Here are the differences between the two types of claims.
Secured claim. Debt is secured if the creditor has the right to take property (collateral) if you fail to pay it. This power creates a “lien” against the property. For instance, a mortgage and car payment are secured debts. If you don’t pay, the creditor can foreclose on the house or repossess the vehicle.
Unsecured claim. An “unsecured” claim isn’t secured by property. Ordinary unsecured claims include credit card balances, utility bills, and personal loans.
The Trustee Pays Unsecured Claims in Priority Order
The trustee’s job is to find money to pay unsecured creditors. As a result, the trustee doesn’t usually get involved in the payment of secured claims, but it can happen. (If you’d like to learn about when the trustee might pay a claim secured by property, see When Will the Trustee Pay Secured Debt in Bankruptcy?)
If money is available to pay unsecured debt, the trustee makes distributions according to the priority ranking of the particular creditor—and the most important of the bunch are highest on the list. Here’s how the funds get dispersed:
- domestic support obligations
- administrative costs (such as trustee expenses and professional fees)
- wages, commissions, and other compensation earned during the 180 days before bankruptcy (up to $12,850)
- deposits for housing or undelivered services (up to $2,850)
- taxes owed to the government falling within particular periods, and
- claims for death or personal injury resulting from the intoxicated use of a motor vehicle or boat.
This list is not all-inclusive but rather a compilation of some of the most common priority creditors. Starting at the top, the trustee will fully pay any creditor falling into the highest category before moving to the next. Nonpriority unsecured creditors, such as credit card balances, utility bills, and student loans, won’t receive anything unless the trustee can satisfy all priority creditors first.
(For further information, see Payment Priority of Unsecured Debt in Bankruptcy.)
Priority Claim Payment Can Lessen Your Nondischargeable Debt
In most cases, paying priority debt comes with an unseen benefit because many priority debts are “nondischargeable” (don’t get wiped out in bankruptcy). As a result, any amount paid with bankruptcy funds will lessen your overall responsibility. Here’s how this plays out in each bankruptcy chapter.
Chapter 7 Bankruptcy
In a Chapter 7 case, the trustee uses any available funds to pay off priority debt first. The trustee's payment will decrease the debt you’ll be left owing after your case is over. If the available funds don’t fully satisfy the priority creditors, you’ll be responsible for the remaining balance (in most instances).
Chapter 13 Bankruptcy
You’ll be required to pay off all of your priority debt in your three- to five-year Chapter 13 repayment plan. For instance, you must fully repay the following nondischargeable debts:
- domestic support obligations, and
The downside is that the required monthly payment can be quite high, and you’ll be ineligible if you don’t have enough income to pay it.
Example. If you owe $15,000 in unpaid child support and $50,000 in overdue taxes, you’ll be required to pay at least $1083.33 per month over the course of a five-year plan. If you have additional amounts that you must repay—such as mortgage arrearages—and not enough income to do so, the court won’t confirm (approve) a Chapter 13 repayment plan.
Student Loans Are Not Priority Debt
Although a student loan is nondischargeable, it isn’t a priority debt, and you won’t have to pay the entire thing in your Chapter 13 plan. As an unsecured claim, it falls last on the list with your other unsecured debt, so a small amount (if anything) will go toward the balance over the course of your case. You’ll remain responsible for the remaining balance after your bankruptcy concludes.
(You can learn more about student loans in Can Chapter 13 Bankruptcy Help Me Lower my Student Loan Payment?)
Questions for Your Attorney
- Do I stand to lose property in a Chapter 7 bankruptcy?
- Do I have any priority debts that I’ll have to pay after my case is over?
- Will the trustee use any funds to pay off my overdue taxes or child support?