Should you leave chapter 13 bankruptcy protection early?

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If you are feeling overwhelmed by your debt, you might be looking for a way out of your predicament. Most people tend to get into this sort of situation when life throws curveballs at them.

For instance, you could lose your job, have a major accident or lose control of your financial situation in some other way. Filing for bankruptcy would offer you a way out of your predicament in a manner that also offers you legal protection from your creditors.

Filing for a chapter 13 bankruptcy allows you to come up with a plan with the approval of your creditors and the legal system to pay off your debt with your earnings over a number of years. This is different from a chapter 7 bankruptcy, which taps into your assets to pay off your creditors.

It could happen that after your chapter 13 bankruptcy plan is approved and you are making inroads into your debt, you might want to get out of chapter 13 earlier than agreed upon. Before deciding if that’s a good course of action, let’s look into what sort of protection a chapter 13 bankruptcy actually offers you.

How does a chapter 13 bankruptcy plan work?

You are eligible to file for chapter 13 bankruptcy protection if your unsecured debts (those that are not backed by any collateral such as a car or a house) total less than $419,275 and your total secured debts (those that do have some property backing them) are less than $1,257,850. The government also regularly adjusts those limits for inflation.

You should also have filed your tax returns for the previous four years. And you would have to attend credit counseling before filing for the bankruptcy.

Once you file your petition—along with a repayment plan—with a bankruptcy court, a trustee will step in to handle the case. This trustee will hold a meeting of your creditors and you will have to answer questions, under oath, that they and the trustee might pose to you. After that, the court will hold a hearing about your chapter 13 bankruptcy case.

This type of bankruptcy is also called a “wage earner’s plan” since it applies to those who get a monthly income to develop a plan to get out of their debt. Your plan will allow you to make these regular payments over a period ranging from three to five years.

If your income is below your state’s median income, your plan will run three years. In cases where the debtor’s income is higher than the state median income, the plan period will run five years. You will be allowed to keep the funds you require from your income to pay your reasonable living expenses. The remainder of your income, which is your disposable income, will go toward paying off your debts.

Early discharge from chapter 13 protection

If by some chance you are able to pay off your debts before your plan ends—maybe you inherit some money, for instance, or won the lottery—you would be able to pay off your debts and exit the plan before it ends.

But some debtors might see a drastic change in their circumstances that makes it difficult for them to make their plan payments. For instance, you might lose your job or your income could go down to the extent that you can’t keep up with your chapter 13 plan commitment.

In such cases, you could apply for a chapter 13 hardship discharge. You will not get all your debts discharged this way. Before discharging your case, unsecured creditors who have made a claim should have received at least as much as they would have under a chapter 7 bankruptcy case.

Leaving chapter 13 protection enables debt collection efforts

Once you file a chapter 13 case, you will have protection from debtors’ collection efforts. There will be a stay against such efforts and collectors will not be able to initiate a case or continue to pursue one, garnish your wages or call you about the debt.

And in case anyone has co-signed a loan with you, a creditor may also not pursue collection efforts with them (unless the bankruptcy court rules to the contrary). Filing for a chapter 13 case also stops foreclosure efforts on your home.

Given that you will be losing all these  protections by leaving chapter 13 protection due to a hardship, it may be in your best interests to only do so as an absolute last resort.