An Overlooked Form of Bankruptcy for Individuals
Bankruptcy Filers Often Overlook the Option to File Under Chapter 13
Many believe the only way to eliminate overwhelming debt is to file under Chapter 7, which generally involves the liquidation of non-exempt assets to pay debts. However, Chapter 7 bankruptcy is not the only option and many do not qualify due to their income being above the threshold. This article will provide a brief overview of Chapter 13 bankruptcy and discuss some of its major benefits.
Brief Overview of Chapter 13 Bankruptcy
Chapter 13 is often referred to as the “wage earner’s plan” because it allows individuals with regular income to develop a plan to pay all or a portion of their debts based solely on their ability to pay, without the requirement to sell off assets and property. Most individuals are eligible for Chapter 13 bankruptcy, including individuals who are self-employed or operate an unincorporated business. However, there are some limits on those who qualify. An individual who has unsecured debts (e.g. credit cards or medical bills) of more than $360,475 or secured debts (e.g. home mortgages or auto loans) of more than $1,081,400 will not qualify for Chapter 13 bankruptcy.
In a Chapter 13 bankruptcy, individuals create a repayment plan where monthly payments are made to the Bankruptcy Trustee over the course of three to five years. The length of the repayment plan depends upon the individual’s current monthly income. If an individual’s monthly income is less than the state median where the bankruptcy case was filed, then the plan will usually be for three years. If the individual’s monthly income is over the state median, then the repayment plan is completed over five years.
Benefits of Chapter 13 Bankruptcy
One of the most significant benefits of Chapter 13 bankruptcy, especially in today’s economy, is the opportunity for individuals to save their homes from foreclosure. When an individual who is threatened by foreclosure files for Chapter 13 bankruptcy, an automatic stay stops the foreclosure proceeding and the individual may make up any past-due mortgage payments over the plan period.
However, in addition to the plan payment, the Chapter 13 debtor must have sufficient income to make regular mortgage payments as they become due following the filing date. As an example, a debtor behind on mortgage payments by $30,000.00 can stop foreclosure and keep his or her home if his or her income is sufficient to make regular mortgage payments going forward, plus a plan payment of $550.00 per month to the trustee (550 X 60 = $33,000.00 = $30,000.00 arrearage plus 10% trustee fee).
If you have recently returned to the work force, or otherwise improved your monthly income situation, this is a valuable opportunity to save your home. Other considerations, such as whether the debtor has equity in the home, may also come into play in determining whether a Chapter 13 filing is warranted.
Some other important qualities of Chapter 13 are that it allows individuals to reschedule secured debts and reduce the amount owed to the value of the collateral over the length of the repayment plan by use of a so-called “cramdown.” The rescheduling of debts may allow for lower monthly payments. Chapter 13 behaves like a consolidated loan where one payment is made to the bankruptcy trustee who allocates payments to creditors.
Again, the payments to creditors are limited by the debtor’s ability to pay which is determined by the debtor’s “disposable income.” Once the plan payments are completed, even if only a small fraction of the total debt has been paid, the unpaid balance is discharged by the Court, like in a Chapter 7.
A Chapter 13 also allows a second mortgage, which is a secured debt, to be treated as unsecured and paid through the plan based on the debtor’s ability to pay. At the end of the plan, the second mortgage is “stripped off” leaving the home as security for only the first mortgage. The amount paid on the second mortgage is limited by the debtor’s disposable income and can be as little as 1 percent.
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