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Chapter 13 


     Unlike Chapter 7, which quickly discharges most debts, Chapter 13 is a repayment plan, which usually lasts between three and five years. During this time, the debtor is paying all of their disposable income, as defined by law, to the trustee for payment over to the debtor’s creditors.

      Chapter 13 does offer some advantages over Chapter 7. One big advantage is that some mortgages can be “stripped down,” that is, taken completely off of a home and fully discharged without paying much, if anything, to the lender. Other mortgages can be “crammed down,” that is, written down in value to the fair market value of the home. Recent attempts in Congress at changing bankruptcy law to allow more mortgages to be crammed down have not been successful.

     The catch is this: Any failure on the part of the debtor to make each and every payment called for by the Chapter 13 plan over the three to five year life of the plan means that the lien is not removed or even reduced, except to the extent that the debtor may have incidentally paid money on the lien while they were making payments.

     Liens are only removed completely or reduced to market value if the debtor completes the plan and receives a discharge. There are countless things that can go wrong during the several years it takes to complete a Chapter 13 payment plan, any of which can put the debtor back to square one.

     Further, these days, liens can often be much more effectively and quickly dealt with by negotiation with the banks through a modification of the loan on the debtor’s home. See the page on Loan Modification for more information.

     Another cost to Chapter 13 is that any significant increase in income will likely result in the debtor having to pay more money to the debtor’s creditors, thus keeping the benefit of that higher income from the debtor until the case is discharged. On the other hand, unavoidable reductions in income can result in a lowering of the required payment from the debtor, or may even allow for an early discharge to the debtor’s benefit.

     Another cost to Chapter 13 is that the total attorney fee is often much higher than for Chapter 7, in large part due to the greater workload required by Chapter 13 cases. Many attorneys will charge an upfront fee that is similar to the fee for Chapter 7, but then charge another $2,000 or so over the first several months of the plan that comes out of the payment that the debtor is making to the trustee.

     Another cost is the 10% or so fee that the debtor must pay to the trustee for handling the payments of the debtor’s case. For example, a $3,300 monthly plan payment means that the debtor is paying about $300 per month to the trustee just in administrative expenses, on top of any payments for attorney fees and debt reduction. Over the life of a five year plan, this cost alone would result in $18,000 extra that the debtor would pay to try to get the benefits of Chapter 13.

     Even before the debtor gets underway with their plan to reduce or eliminate debts in Chapter 13, several qualification hurdles must be overcome. First, the debtor must have sufficient income to make the payments that must be made in the plan. No chapter in bankruptcy can create income for the debtor, or get rid of liens on secured debts. If the debtor doesn’t have enough income, the plan will not pass the “feasibility test.”

     Also, the debtor’s creditors must receive as much in a Chapter 13 bankruptcy as they would in a Chapter 7. This is referred to as the “best interests of the creditors test.” Put simply, if the debtor has a significant amount of equity in assets, then the creditors must be paid in full through the plan, on top of the fees for the trustee and attorney. Negotiations with these creditors might be a much better solution than an expensive and risky Chapter 13 filing.

     Further, a debtor must not have more secured and/or unsecured debt than allowed by bankruptcy law. If a debtor owns more than a couple of houses, the debt limits of Chapter 13 may well be exceeded. If the homes have some equity, but large loans, the secured debt limit of approximately $1 million may be exceeded. If the homes have negative equity, then the unsecured debt limit of $336,900 may easily be exceeded. Large credit card debts can also easily disqualify a debtor from Chapter 13.

     A debtor who is not well-suited for a Chapter 7 filing, and does not qualify for a Chapter 13 filing, has only Chapter 11 remaining as an option for bankruptcy protection. The costs for this latter chapter rise dramatically, and creditors have a much greater say in the outcome of the debtor’s finances.

     In short, Chapter 13 does offer some favorable options to some debtors in specific circumstances. Usually, however, if a debtor qualifies for Chapter 7 under the Means Test, and does not stand to lose much, if any, assets by filing under that chapter, then that form of bankruptcy will almost always result in the best outcome for the debtor.


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with Dale Orthner, call:

(916) 588-5011

Dale Orthner
(916) 588-5011