- CREDIT and DEBT
- DEBT MANAGEMENT
What Is Chapter 13?
Chapter 13 is a type of bankruptcy proceeding in which debtors agree to a reorganization of their financial obligations under the supervision of a court. Individuals and married couples, even if self-employed or operating an unincorporated business, are eligible to file for Chapter 13 bankruptcy. Here's how Chapter 13 works, in addition to how it compares with other types of bankruptcy.
KEY TAKEAWAYS
- Chapter 13 is a form of bankruptcy that allows debtors to restructure their debts and pay them off over a period of three to five years under court supervision.
- Filing for Chapter 13 bankruptcy can stop foreclosure proceedings that would have led to the seizure of the debtor's home.
- Debtors must still pay all of their secured debts, such as mortgages and car loans, in full.
- A debtor may only pay a portion of what they owe in unsecured debts, such as credit cards.
How Chapter 13 Works
To apply for a Chapter 13 bankruptcy, also known as a wage earner's plan, debtors must compile a list of all of their creditors along with the amount of money they owe to each, a list of any property they own, information about their income and its sources, and details about their monthly expenses.
With the aid of a court-appointed bankruptcy trustee, they then submit a plan for repaying their creditors within a period of three to five years. In most circumstances, the repayment plan must provide a substantial payback to creditors—at least equal to what they would receive under other forms of bankruptcy. It can, if needed, use 100% of the debtor's disposable income for repayment.
The debtor then pays an agreed-upon sum of money each month to the trustee, effectively consolidating the debts into a single monthly payment. The trustee, in turn, distributes the money to the debtor's creditors. Debtors have no direct contact with their creditors under Chapter 13 protection.
At the end of the repayment period, any remaining debts, with certain exceptions, will be discharged by the court, meaning that the debtor is under no obligation to pay them.
People are eligible to use Chapter 13 only if their total debt is under a certain limit, currently $2.75 million in unsecured and secured debt combined. They must also have completed credit counseling to be considered eligible for Chapter 13.
Types of Debt in Chapter 13
Under Chapter 13, debts, or claims, fall into three categories: priority, secured, and unsecured.
Priority debts include tax obligations, alimony, and child support.
Secured debts are those backed by some form of collateral. In the case of a mortgage, for example, the home itself typically serves as collateral. With a car loan, it's usually the vehicle. When a debt is secured, the creditor has a right to seize the collateral if the debt goes unpaid.
Unsecured debts are not backed by collateral. Credit cards are the most common example of unsecured debt.
In a Chapter 13 bankruptcy, the first two types of claims—priority and secured—must be paid in full unless the creditor agrees otherwise. Unsecured debt, however, doesn't have to be repaid in full and often isn't.
Chapter 13 Bankruptcy Example
After Eric lost his job, and his husband, Joey, suffered a medical crisis that left him unable to work, they fell behind on their mortgage and were $25,000 in arrears. The bank had initiated foreclosure proceedings just as Eric received a job offer.
By filing for Chapter 13 bankruptcy, they were able to stop the foreclosure and remain in their home. With their now-steady income, they are able to pay their mortgage each month while also spreading the $25,000 back payment over a five-year period.
However, if they fall behind in their payments in the future, the bank could foreclose again.
Chapter 13 vs. Chapter 7
Chapter 7 is the most common form of bankruptcy, as it allows individuals to erase most of their existing debt and start afresh. Unfortunately, Chapter 7 filers are often required to surrender their home. Once a Chapter 13 bankruptcy is initiated, any home foreclosure proceedings are ceased. For that reason alone, a debtor who wishes to keep their home may choose Chapter 13 over Chapter 7.
In addition, Chapter 7 has a much lower threshold for how much income a debtor can earn and still be eligible for it than Chapter 13 does.
Chapter 13 vs. Chapter 11
Chapter 11 bankruptcy is another plan in which debt is restructured with court approval and paid back over time. Although it's available to individuals, couples, and businesses, Chapter 11 is filed most frequently by businesses because it's expensive and complicated.
Chapter 13 gives filers who make too much money to be considered for Chapter 7 an easier alternative to Chapter 11. Filing for Chapter 13 bankruptcy may also protect any co-signers of the debtor's loans from being held responsible for them.
How Many Types of Bankruptcy Are There?
There are six types of bankruptcy outlined in U.S. Bankruptcy Code. In addition to Chapter 13, Chapter 7, and Chapter 11, described above, there are three more specialized chapters. Chapter 9 is for municipalities, Chapter 12 is for farms and fisheries, and Chapter 15 is for cross-border bankruptcies.
How Does Chapter 13 Bankruptcy Affect Your Credit Score?
According to FICO, the company behind the most widely used credit scoring models, that depends on how high (or low) your credit score was to begin with.
A person with "a very high FICO Score could expect a huge drop in their score. On the other hand, someone with many negative items already listed on their credit report might only see a modest drop in their score," FICO says.
"As long as the bankruptcy is listed on your credit report, it will be factored into your score," FICO notes. But, "as time passes, the negative impact of the bankruptcy [on your credit score] will lessen."
How Long Does Chapter 13 Bankruptcy Stay on Your Credit Report?
A Chapter 13 bankruptcy filing will generally remain on your credit report for seven years.
The Bottom Line
Chapter 13 bankruptcy can allow individuals or couples to restructure and repay their debts without necessarily losing their homes or other property. Like all forms of bankruptcy, however, it can have serious long-term consequences, so anyone considering it should also look at the potential alternatives first.
- Chapter 7
- Chapter 9
- Chapter 10
- Chapter 11
- Chapter 12
- Chapter 13 CURRENT ARTICLE
- Chapter 15
- Chapter 7 vs. Chapter 11
- Chapter 11 vs. Chapter 13