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Chapter 13 (also called a reorganization) bankruptcy is a legal process that allows you to restructure your debt so that it’s more manageable. During the process, you and your creditors will design a repayment plan that lasts from three to five years. After you complete the plan, any remaining debts get discharged and you will be out of debt.
Chapter 13 bankruptcy filings hit their highest level in the United States in 2010 when they reached 434,739 non-business filings. By 2020, Chapter 13 bankruptcy filings declined to 155,227, with a slight increase during the Covid-19 pandemic.
Because filing bankruptcy has long-term financial consequences, you should understand how Chapter 13 works before taking the next steps.
How Chapter 13 bankruptcy 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.
A report from the American Bankruptcy Institute, shows that filing Chapter 13 bankruptcy with the help of an attorney has a more successful outcome than pursuing credit counseling. While results vary somewhat from state to state, between 40 percent to 70 percent of Chapter 13 cases complete repayment successfully.
Once the judge approves your proposal, you’ll send a monthly payment to a court-appointed trustee who collects and distributes 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. Because 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.
Eligibility requirements for Chapter 13
Generally, people choose Chapter 13 when their monthly debt payments are too much to handle but they have a job or a source of income 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.
Who should file for Chapter 13
Chapter 13 bankruptcy is aimed at people who have a consistent source of income despite the fact that it isn’t sufficient to handle their debts.
Declaring bankruptcy in any form has massive financial consequences and ramifications. You give up some level of control over your finances in exchange for help with getting out of debt. If you complete the process, you’ll have eliminated your debt but also damaged your credit significantly.
That means that bankruptcy should be an option of last resort after trying everything else you can think of to manage your bills and pay your debts. It shouldn’t be the first place you look to.
Chapter 13 in particular involves making good-faith efforts to pay your debts. That’s why it’s called a reorganization bankruptcy while Chapter 7 bankruptcies are called liquidation bankruptcies.
If you still have a solid job or way to make money, but simply can’t afford to fully pay what you owe, Chapter 13 is a good option to take. It lets you maintain more control over your finances and assets than you would with a Chapter 7 bankruptcy.
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.
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. To file for Chapter 13 as an individual, your combined secured and unsecured debts total less than $2.75 million.
- 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.
- 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.
- 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.
- 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 the proposed plan.
- 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.
- 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.
Alternatives to Chapter 13
Chapter 13 is not the only option available to individuals who are seeking to address overwhelming debt. Chapter 7 is another choice that can provide relief from creditors.
As part of a Chapter 7 bankruptcy, nearly all of your debt is erased or discharged, making it slightly different from Chapter 13, which simply reorganizes your debts. In order to discharge debt under Chapter 7 bankruptcy, however, non-exempt personal property of value is sold and the money earned from the sale of your items is used to repay creditors. Any remaining debt will be discharged, with the exception of student loans, child support, taxes and alimony.
Chapter 7 may be a good choice for those who do not have the ability to repay debts through a reorganization plan. In order to qualify for Chapter 7, you will typically have to undergo a means test to confirm that you truly do not have the financial resources to pay back outstanding debts.
There are pros and cons to this approach to be aware of before proceeding. Like any bankruptcy filing, pursuing Chapter 7 negatively impacts your credit score, remaining on your report for 10 years. In addition, when filing Chapter 7, you will need to be prepared to sell assets and personal belongings. In most cases, a court-appointed trustee takes charge of liquidating or selling some of your possessions in order to repay creditors.
On the positive side, however, Chapter 7 is often seen as a way to give yourself a fresh start, allowing you to eliminate all unsecured debt.
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 on 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.
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.