How to Choose the Right Bankruptcy Chapter: When Chapter 13 Makes Sense

By Cara O'Neill, Attorney
Chapter 13 bankruptcy might be right for you if you need to save your house, car, or other property; if you have nondischargeable debts, such as past due taxes or support arrearages; or if you've recently filed for Chapter 7 bankruptcy.

Many consumers assume that a Chapter 7 bankruptcy (which wipes out most debt and is over in a matter of months) is preferable to a Chapter 13 approach (where you repay many debts over a period of years). But just because you want to file for Chapter 7 bankruptcy doesn’t mean you’ll qualify to do so—and even if you do qualify, it doesn’t solve every financial problem. Sometimes filing for Chapter 13 bankruptcy offers you a better solution. Not only can you keep all of your property, but you can also stop your creditors’ collection attempts and pay off your debt over three to five years.

Read on to learn about the circumstances that will determine whether Chapter 13 is the better fit for you.

Your Income and Your Expenses

Bankruptcy law offers the Chapter 7 solution to certain consumers only—specifically, those who pass what’s called the “means test.” The means test evaluates your income, certain expenses, and the cost of living in your area. You’ll pass if your income is below your state’s median income for your household size. But even if you pass, you are not required to file for Chapter 7. You can still, if you wish, opt for Chapter 13.

If you don’t pass the means test, you must file for Chapter 13 bankruptcy (or Chapter 11 bankruptcy, if your debt exceeds the current Chapter 13 debt limits). Simply by failing the means test, the law considers you to have extra money, called “disposable income,” to pay to your creditors. Of course, you might not agree if, in fact, you don’t have anything left over at the end of the month. If that’s the case, it’s likely that you’re living above what the court views as a reasonable standard of living, and you’ll need to tighten your belt to take advantage of Chapter 13 bankruptcy.

Keeping Your Nonexempt Property

In both Chapter 7 and 13 bankruptcies, you get to keep, or “exempt” certain assets, such as an inexpensive car, household furnishings, and the funds in most retirement accounts. (To find out how much property you can exempt, you’ll want to review your state’s property exemption tables.) But what about nonexempt property, such as a vacation home and the small boat tied to the adjacent dock, or the RV that you and the family plan to use when visiting the Grand Canyon this summer? Many consumers shrink from the prospect of losing property that is nonexempt but near and dear to their hearts. In a Chapter 7 bankruptcy, you’d be out of luck, but not necessarily so if you file Chapter 13. But it’s going to cost you.

Here’s the catch. If you want to retain more property than you can exempt, you must pay your creditors as much as the property is worth after deducting any portion you’re allowed to exempt. Put another way, creditors must get at least as much as they would have received in a Chapter 7 case (where the bankruptcy trustee would sell the property and use the proceeds to satisfy creditors). Therefore, if a Chapter 7 bankruptcy trustee would have sold that boat for $10,000, your creditors must get at least $10,000 in your repayment plan.

Example. Julie has $125,000 in equity in her house, but her state’s exemption statute allows her to protect only $100,000. She knows she’d lose the house if she files for Chapter 7 bankruptcy because the trustee would sell it, give her the first $100,000 (her exemption amount), and give the remaining $25,000 to her creditors. Filing for Chapter 13 bankruptcy allows her to keep the house. But she must pay her creditors at least $25,000 over the course of her repayment plan.

Saving Your House From Foreclosure or Your Car From Repossession

If you’ve fallen behind on your mortgage or car payment and can’t immediately catch up, all is not lost. You can save your house from foreclosure, or your car from repossession, by filing for Chapter 13 bankruptcy and bringing your payments current over three to five years (as long as you have enough income to do so).

When you’re behind on your payments, you won’t make your payment directly to your lender, or “outside the plan.” Many trustees require you to pay both the monthly payment and arrearages “inside the plan,” meaning that you’ll send the payment to the trustee. The trustee then pays your creditor.

If you’re behind on a car payment, you must pay off the car over the course of the plan. That’s not the case for your mortgage, however, because it is considered a long-term debt. If you’re behind on your mortgage, you’ll only have to make your monthly payments and catch up on the arrearages. You’ll continue making your mortgage payments once you’ve completed your repayment plan.

Example. Keith came down with a severe illness that prevented him from working for several months. Because he was out on disability, he couldn’t meet his $2,000 per month house payment, and now he’s $8,000 behind. To save his house from foreclosure, he can file for Chapter 13 bankruptcy and catch up on his arrearages. Over the course of a five-year plan, he’ll pay $128,000 (60 months x $2,000 + $8,000 in arrearages), plus interest and administrative expenses, such as attorneys’ fees and trustee fees.

Debt That Won’t Go Away in Chapter 7 Bankruptcy

Some debt is “nondischargeable debt,” which doesn’t get wiped out in bankruptcy, whether it’s Chapter 7 or 13. You’re stuck with it until you pay it off. If you’re behind on a nondischargeable debt, such as your spousal support, and your ex-spouse won’t work with you, filing for Chapter 13 bankruptcy allows you to make up your back support over a three- or five-year repayment plan. By contrast, filing for Chapter 7 bankruptcy would not give you extra time to pay the obligation. After you had received your discharge, you’d be in the same position as before you filed for bankruptcy—at least for your outstanding support.

Other examples of nondischargeable debt include:

Example. Suppose you’re behind on your taxes to the tune of $20,000. There’s no way you can pay it in one lump sum, and the taxing agency is threatening to take 25% out of your monthly paycheck (a wage garnishment) and empty your bank account (a bank levy). If you were to file for Chapter 7 bankruptcy, you’d find yourself in the same predicament after receiving your discharge, because Chapter 7 doesn’t wipe out nondischargeable debts and doesn’t allow you to pay obligations over time. But by filing for Chapter 13 bankruptcy, you can prevent both the bank levy and wage garnishment and pay the $20,000 balance over a three- or five-year repayment plan.

Filing for Bankruptcy Twice Within Eight Years

You’re entitled to a Chapter 7 discharge only once every eight years; however, sometimes you need bankruptcy protection sooner. In that case, you can file for Chapter 13 bankruptcy. The only caveat is that you won’t receive a Chapter 13 discharge after completing your plan unless four years have passed since you last filed for Chapter 7 bankruptcy.

To better understand how filing a subsequent bankruptcy affects your obligations, it’s a good idea to consult with a local bankruptcy attorney.

Questions for Your Attorney

  • Can I file for Chapter 13 bankruptcy if I don’t have enough income to fund a monthly repayment plan?
  • What happens if I lose my job during my repayment period?
  • Can I file for Chapter 13 if I own a business?
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