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Is paying off Chapter 13 bankruptcy early a good idea?

A stressed out woman and man look over bills while sitting on a couch.
David-Prado/Getty Images
A stressed out woman and man look over bills while sitting on a couch.
David-Prado/Getty Images

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Sometimes called “wage earner’s plan” or “reorganization bankruptcy,” Chapter 13 bankruptcy is available for people who intend to repay some or all of their debt without liquidating their assets. It spreads the debt burden out into payments that are made over a three to five year period, based on the person’s income, allowing them to pay back what they owe through installments.

Making payments toward a Chapter 13 bankruptcy plan can feel like a long journey, which can make it tempting to pay it off early if possible. If you received a windfall — such as an inheritance, lottery winnings or a large bonus at work — you might be thinking about paying the debt in full.

Before making a lump sum payment to get out of Chapter 13 bankruptcy, be aware of the repercussions of an early payoff. While you might be able to rid yourself of the burden of the repayment plan, you may end up paying more than your original agreement.

Should I pay off my Chapter 13 bankruptcy plan early?

In most cases, paying off Chapter 13 early isn’t a good idea. By paying off Chapter 13 early, you’re required to repay 100 percent of the debt you owe to your creditors instead of the reduced amount.

When you file your Chapter 13 case, your bankruptcy trustee and you or your attorney decide on a reasonable amount of debt — generally, less than what you actually owe — that you could manage to pay back to your creditors.

For example, instead of repaying 100 percent of the debt that’s included in your bankruptcy claim, the court might only require payment for 70 percent under the plan. This amount is based on your assets, monthly income and monthly expenses. Once you finish your Chapter 13 repayment plan, the remaining 30 percent of your debt is discharged, meaning you won’t have to repay that remaining debt.

If you pay your Chapter 13 plan off early, you alter the agreed upon terms of your bankruptcy case. Now, you’ll be responsible for paying your creditors all of your original outstanding debt, including the amount that would’ve been discharged.

The rationale is simple: If you have the means to make a lump-sum payment on the plan, then you should be able to continue making monthly payments until the remaining balances are also paid.

How paying off Chapter 13 bankruptcy early works

If you find yourself with a sudden influx of cash and you decide that you want to use it to pay off your Chapter 13 bankruptcy early, here’s how it works: First, you’ll need to confirm your finances are secure. That means making sure you have enough money not just to pay down the debt in full, but also to continue covering your essential living expenses like housing, food and utility bills.

Once you’ve confirmed your finances are all in order, you’ll need to formally request an early payoff from your creditors. They will need to approve the request, which will likely involve a negotiation to recoup more of your debt than your settlement agreement required.

After both you and your creditor have come to terms and agreed to the payoff, a court determines if the payoff will move forward. Assuming it is, you will be responsible for paying off all of the debt claims on your bankruptcy case, including any unsecured debt, such as credit cards, which would’ve been discharged if you’d kept making Chapter 13 plan payments on the original schedule.

Advantages of paying off Chapter 13 bankruptcy early

There are a handful of circumstances in which you might decide to pay off your Chapter 13 bankruptcy early, most of which stem from lifestyle choices that may offer more personal comfort and convenience than making ongoing debt payments.

Free of debt earlier

There is a mental and emotional burden to debt payments and the knowledge that you owe money to someone else. Choosing to pay down your debts early frees you of that concern and can be a relief knowing that you don’t have to worry about meeting monthly payments going forward.

Potential to start fresh sooner

By paying off your debts, you have the opportunity to start fresh. While there are still financial hurdles that will keep you from being able to fully escape the effects of bankruptcy, including a record of it on your credit history, it still provides the opportunity to focus on rebuilding your creditworthiness.

Ability to use disposable income freely

Chapter 13 bankruptcy payments are based on disposable or discretionary income — the money that you have available to you after essentials are accounted for. Making payments toward a bankruptcy agreement means living a very frugal lifestyle where most of your disposable income is tied up in repaying your debts. Paying down your debts in full frees up access to those funds again.

Disadvantages of paying off Chapter 13 bankruptcy early

While it might be tempting to rid yourself of your debts entirely ahead of schedule, the truth is that in most cases, paying off your Chapter 13 bankruptcy early does not make sense.

Paying full debt amount

If you choose to pay off your debt in a lump sum payment, you’ll be required to pay off your debt in full. By continuing to make payments as dictated by your repayment plan, you’ll only have to pay an agreed-upon percentage of your debt over a three to five-year period — at the end, any remaining debt is discharged. To end the agreement early, you’ll have to pay back everything instead of the reduced amount.

Objections from creditors

If you try to request an early payoff, you are likely to face objections from your creditors. Instead of agreeing to a lump-sum payment, they are likely to push for larger monthly payments for the duration of your payback period. The result could be steeper monthly payments based on your increased discretionary income and no relief.

Won’t improve credit history

While it’s tempting to pay off your debt and start over, you won’t be able to rid yourself of the Chapter 13 bankruptcy that will appear on your credit history any faster. It will remain on your credit history for seven years from the date you file, and early payoff won’t clean your credit slate earlier.

How to decide if paying off your Chapter 13 plan early is right for you

There are only a few exceptions when paying Chapter 13 off early won’t result in a higher debt amount, but your attorney or the trustee assigned to your case would have to research whether one exists in your bankruptcy district.

More likely than not, you must stay the course and continue to make payments for the remainder of your plan if you don’t want to risk increasing your monthly Chapter 13 payment amounts.

The bottom line

Paying off your Chapter 13 bankruptcy plan early in a lump sum is likely not the best option going forward. If you are in a position where it may fit to do so, talk with your attorney first.

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Written by
AJ Dellinger
Contributing writer
AJ Dellinger is a contributing writer for Bankrate. AJ writes about auto loans and real estate.
Edited by
Loans Editor, Former Insurance Editor