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
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
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
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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