What you need to know about Chapter 13

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When you’re behind on bills and debt collection notices keep piling up, you might consider declaring bankruptcy. You have a few options, but Chapter 13 is geared toward individuals with a regular income. It’s even called a “wage earner’s plan” because you use your income to repay some of your debts over the course of three to five years. At the end of that period, most of your remaining debts can be discharged.

Between 2005 and 2017, about 4.1 million Americans filed for Chapter 13 bankruptcy. But because this process has long-term financial consequences, you should understand how Chapter 13 works before taking the next steps.

What is Chapter 13 bankruptcy?

Chapter 13 bankruptcy is a legal process that allows you to restructure your debt so it’s more manageable. Over three to five years, you’ll pay your creditors a portion of the outstanding debt. At the end of your repayment plan, any debt that remains may be “discharged,” which means you no longer have to pay it. Because you’ll pay most — if not all — of your debt, Chapter 13 is sometimes referred to as a “reorganization.”

How it works

With the help of an attorney, you’ll file a petition for Chapter 13 with a bankruptcy court, along with a proposal for repaying your creditors over time. Although you’re not required to hire an attorney, their knowledge may help your chances of success.

In a 2017 study by the American Bankruptcy Institute, 41.4 percent of bankruptcy filers who hired an attorney completed their repayment plans, compared to just 2.3 percent of people who represented themselves.

Once the judge approves your proposal, you’ll send a monthly payment to a court-appointed trustee. That person will collect and distribute payments to your creditors over a period of three to five years.

Why someone would file for Chapter 13

Here are some of the reasons Chapter 13 can be your best avenue:

  • You may be able to keep your home. Chapter 13 can allow a debtor behind on mortgage payments and facing foreclosure to catch up on payments, reinstate the mortgage and stay in the home.
  • Co-signers may not be held responsible legally. A section of Chapter 13 law known as the “co-debtor stay” prevents creditors from going after anyone who co-signed for you on a debt.
  • You have a right to sell your property. Since you have made arrangements to repay your creditors, you are free to sell your property at a time when it will generate the greatest value.
  • You can keep your business up and running. If you are a sole proprietor, Chapter 13 allows you to continue to do business. It is important to remember that your business must produce enough income to help you make monthly Chapter 13 payments.
  • Your debt is frozen. All debt on unsecured claims are frozen the day you file for Chapter 13, meaning payments you make to your creditors are used to pay down debt, rather than being eaten up by interest and late charges.

How do I know if I should file for Chapter 13?

Generally, people choose Chapter 13 when their monthly debt payments are too much to handle but they have a job and want to keep certain assets. If you’ve maxed out your credit cards, you can’t afford to pay for basics like groceries and you’re constantly avoiding phone calls from debt collectors, you might consider this route.

Bankruptcy can have long-lasting effects on your credit and financial options going forward, so talk with a credit counselor or a bankruptcy attorney first. They can help you decide if this is the right move for you.

How to file for Chapter 13

If you’re considering Chapter 13 bankruptcy, it helps to know whether you might qualify and the steps involved. The process might take about three to four months before you start the repayment plan.

Prerequisites

When you file for Chapter 13 bankruptcy, you’ll need to meet certain requirements. The court will check that:

  • You earn a regular income. If your income is lower than the median level in your state, then you’ll repay your debt over three years. But the court may allow you to repay your debt over five years if your income exceeds the state median.
  • You’re not behind on taxes. The court may ask to see several years’ worth of filed tax returns.
  • Your debts do not exceed the limit. The debt limits for filing Chapter 13 are $419,275 in unsecured debt and $1,256,850 in secured debt.
  • Sufficient time has passed since your last filing. You may receive a discharge as long as you haven’t filed for Chapter 13 within the past two years and Chapter 7 within the past four years.

Steps for filing Chapter 13

There are several steps you must legally take to prepare for the bankruptcy process and file your petition correctly. An attorney can help you navigate these steps so you can eventually complete your repayment plan.

  1. Find an approved credit counselor to help you weigh your options. If you decide to move forward with bankruptcy, you can hire a bankruptcy attorney to help you fill out the paperwork.
  2. File a bankruptcy petition with your local bankruptcy court, along with $310 in fees and a payment proposal that explains how you plan to repay your creditors.
  3. Meet your court-appointed trustee, who will review your case and organize your creditor meeting. At the meeting, you’ll answer questions about your debt and proposed plan.
  4. Attend a confirmation hearing, where a judge will review your petition and decide if you have the means to follow through with your proposal. Based on that decision, you’ll either move forward with Chapter 13 or be required to modify the plan or file Chapter 7 bankruptcy instead.
  5. Follow the repayment plan over three to five years. Your trustee will collect and distribute payments during this time. Once you’re done with repayment, the bankruptcy case will be discharged.

Final considerations

A Chapter 13 bankruptcy typically stays on your credit reports for seven years from the date you filed the petition. That can lower your credit score by around 130 to 200 points, but the effects to your credit diminish over time.

While your credit heals, it may be hard to qualify for new credit, pass an employment background check, apply for a mortgage or get the best interest rates on credit products. There’s also pressure to keep up with your three- to five-year plan because missing payments could lead to a dismissal. In that case, you stand to lose any assets you were trying to protect.

Next steps

If you’re struggling with paying your bills and fielding calls from debt collectors, talking with a credit counselor will help. They’ll help you look over your budget, credit and debts to help you piece together a plan.

Chapter 13 might be the right solution to help you get your finances back on track. Look for a reputable bankruptcy lawyer and check whether you qualify for free legal services.

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