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Chapter 13 Bankruptcy: Everything You Need to Know

If you are struggling with debts and simply cannot catch up, then bankruptcy can give you a fresh start. It is important to understand how the bankruptcy process works and what can and cannot be discharged under bankruptcy before proceeding. Learning more about your options can help you to determine if bankruptcy is right for you now and for your future.

What Is Bankruptcy?

Bankruptcy is a legal process that provides you with a way to repay some or all of your debt. In some cases, you will retain your assets and continue to make payments; in others, your debt will be eliminated. There are two kinds of bankruptcy: Chapter 7 and Chapter 13. The type you choose will depend on your financial situation and desired outcome.

Chapter 7 vs. Chapter 13 Bankruptcy

The difference between Chapter 7 and Chapter 13 bankruptcy is as follows:

  • Chapter 7 bankruptcy: If you are a consumer, you may choose Chapter 7 bankruptcy. It is the most common form used by individuals. In this case, any non-exempt assets can be sold to pay off your creditors. This is a relatively swift process and allows you to get back on track quickly. If you simply do not earn enough to pay your debts and want to get a fast fresh start, Chapter 7 bankruptcy can help.
  • Chapter 13 bankruptcy: This form of bankruptcy is more involved than Chapter 7 and allows you to structure repayments and catch up. You will make payments for three to five years and those payments will be distributed to your creditors. If you earn an income and have assets you want to keep, then Chapter 13 bankruptcy is often the ideal option. Once you have made all the payments you are required to (which may not be the full amount of the debts), your remaining debts are discharged.

Chapter 13 Bankruptcy and the Family Home

Chapter 13 bankruptcy is often used to save the family home in a time of crisis. High late fees and interest payments mean that mortgage payments can add up fast and homeowners can rapidly fall behind and risk foreclosure after a single missed payment. Chapter 13 is structured in a way that allows you to pay those late, unpaid payments over time instead of in a lump sum as demanded by your lender.

If you earn enough to make your current mortgage payments and the arrears but simply cannot come up with the full amount all at once, then Chapter 13 bankruptcy can help.

Bankruptcy and Foreclosure

The foreclosure process varies by state. If you are unable to pay your mortgage payments and fall behind, your lender can begin the foreclosure process. Eventually, your home would be sold at auction to recover the lender's costs.

Each state has different laws regarding the foreclosure process, and the actual length of time varies. Some states require judicial intervention and rulings, while others do not. It involves numerous steps, including notification to the homeowner. If you are facing foreclosure, then bankruptcy can help save your home and allow you to get caught up.

What Is an Automatic Stay?

When you file for bankruptcy, the local court automatically creates an order, or an automatic stay. This means that creditors need to stop their collections attempts right away. If you have been harassed by phone calls from collectors or are facing foreclosure, the automatic stay puts a temporary halt to this process.

Your lenders can file a motion to lift the automatic stay (often granted to a mortgage lender or if the lender has already filed for foreclosure). If you have already received a notice of foreclosure, the stay may not be as helpful. Your attorney can help you learn more about automatic stays and if this helpful component of bankruptcy will be beneficial for you.

When to File Chapter 13

How can you tell if Chapter 13 is right for you and if it is truly time to file for protection? Look out for these signs and consult with an attorney to determine if the time is right:

  • You need an automatic stay – If you are in danger of losing your home, the automatic stay provided by bankruptcy can give you the time you need to reorganize and save your largest asset.
  • You need a fresh start – If your finances are so out of control that the only solution is to start over, bankruptcy could be an option. This is best for those with unsecured debts. Some debts, including student loans, will not be impacted by bankruptcy much at all.
  • You can retain your property – If you know you need to file for bankruptcy but have been afraid of losing assets, Chapter 13 can help you eliminate debt without losing the things you have worked hard to attain.
  • You own a business – Filing Chapter 13 will allow you to continue running your sole proprietorship or LLC as you repay your debt.

Bankruptcy and Your Assets

When you file for Chapter 13 bankruptcy, you can keep all your assets. If there is something you are still making payments on, though, you will need to continue making payments through bankruptcy. Some of your debts will need to be paid off in full during this process, while others may be reduced according to your income and expenses.

Secured Debts

Secured debts are those that have collateral, such as your home, your car, and other obligations that fall into this category. The secured debt will need to be included in your proposed plan and you will need to be able to remain current as you work through the Chapter 13 process.

Unsecured Debts

Unsecured debts are those that are not secured by a specific piece of property. Credit cards, store cards, and other debts are considered unsecured. While you will usually have to pay all of your secured debts, you may not have to pay all of your unsecured debts. You will have to use all of your disposable income to pay these debts, but the amount of income you have that is considered disposable will vary. Your secured debts get paid first, and unsecured creditors get anything left over.

Disposable income is the money you have left after you pay your needed living expenses like shelter, food, and transportation. Any disposable income needs to be directed to your bankruptcy plan to pay your debts. As part of your Chapter 13 plan, you will complete a means test, which will determine how your income matches up to the average income in your area. If your income is higher, you will complete the whole test to come up with the amount you will have to pay toward your plan. If your income is lower than average, you do not have to complete the rest of the test. Your disposable income will be calculated directly from your income and expense figures.

Car Loans

What happens to your car or truck when you file for bankruptcy? You should be able to keep your vehicles; the exception would be a car with an extremely high payment that you just cannot afford. Chapter 13 allows you to “catch up” on payments for your vehicle, just as it does for your home. Your car expenses must be in line with your income and be reasonable; a luxury car may not be considered a necessity and you may not be able to claim that expense as a needed cost on your plan. You will not have to give up the car, but some of that luxury cost could be considered disposable income.

Child Support Obligations and Bankruptcy

Your bankruptcy will not eliminate or discharge your child support obligations, but it could give you the time you need to catch up. You will still need to make payments as you go through the process. Child support is considered a priority debt and needs to be paid throughout the process. Any arrears need to be paid in full by the time the process is complete.

Bankruptcy Costs

The costs associated with bankruptcy will vary depending on where you live and the attorney you choose. Since Chapter 13 is for reorganizing debt, it can take some time—you will be making debt payments for several years. These are not fees, though; they are simply the money you already owe your creditors.

Under bankruptcy law, attorney’s fees are supposed to be reasonable and could be reviewed by the bankruptcy court. Most attorneys are aware of and comply with reasonable fee guidelines laid down by local courts. The fees you pay cover preparing and filing your bankruptcy and could include things like motions to defend you from a relief of stay from a secured creditor. Chapter 13 fees can often be paid as part of the plan. You will need to consult with your attorney to determine what can be done.

Student Loans and Bankruptcy

Your student loans will not be wiped out by bankruptcy; these federal debts are considered non-dischargeable. Your student loans will be paid back as part of your bankruptcy plan. If you have fallen behind, Chapter 13 bankruptcy allows you to catch up. You will still need to make student loan payments when your bankruptcy ends if there is still a remaining balance after you have completed the process.

Taxes and Bankruptcy

Bankruptcy will not discharge your tax debts; you will continue to pay them as part of your Chapter 13 plan. Some taxes are given higher priorities than others, but all need to be paid back. Tax liens, property taxes, and other taxes will all need to be paid as part of your bankruptcy plan. Since bankruptcy will not alleviate your tax debt, you should only file if you have other unsecured debts that can be eliminated by the process.

After Bankruptcy

In many ways, bankruptcy gives you a fresh start, but there are some challenges ahead. Your credit already took a big hit when you fell behind, and Chapter 13 bankruptcy will remain on your credit report for 10 years. This can impact your ability to get new credit or secure new loans. Making payments on time will help, particularly as time passes.

Regular Payments

If you have used Chapter 13 bankruptcy to retain your home, making regular mortgage payments will help you build a good payment record. Your car loan payments will work in the same way. The worst time for your credit will be while you are actively in the bankruptcy. Once you are done with the process, you should be able to begin reestablishing a credit history and resume making regular, timely payments.

Bankruptcy is a serious step with far-reaching implications, but if you need to protect your assets and your family home, then Chapter 13 bankruptcy can help. Learning more about your options and what to expect from the process can help you to make the right decisions for yourself and your family and ensure you get the fresh start you need from the process.

Next Step: Create a Chapter 13 Bankruptcy Worksheet

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