When most people think of the concept of “bankruptcy”, they usually are thinking of Chapter 7 bankruptcy, which is the more common type of bankruptcy filing. In Chapter 7, the debtor is required to turn over non-exempt assets (if any) in exchange for a discharge of most debts. The process is normally fairly straightforward, and a Chapter 7 case is typically completed within 3½ months after filing. There are some circumstances, however, where a Chapter 13 bankruptcy is the preferable option.
Boiled down to its essentials, a debtor in Chapter 13 bankruptcy makes monthly payments to the Chapter 13 Trustee over a three-to-five year period under a court-supervised Chapter 13 Plan. The monthly payments, and the length of the Plan, depend on (1) the debtor’s assets, (2) his/her income and expenses, and (3) the types of debts involved. The Chapter 13 Trustee then makes payments to various creditors under the terms of the Plan. Unsecured creditors are generally paid some percentage of what is owed, depending on the debtor’s ability to pay. At the end of the case, the remaining debt, with some exceptions, is discharged.
Chapter 13 bankruptcy can be a very powerful tool when a Chapter 7 will not work. The advantages to a Chapter 13 bankruptcy involve, among others, the following situations:
1. Saving A Home From Foreclosure. Chapter 13 bankruptcy can be used to save a home from foreclosure as long as the case is filed before the foreclosure sale. In Chapter 13, the foreclosure proceedings are stopped, but the debtor must continue with regular monthly mortgage payments after the case is filed. The back payments are cured as part of the Chapter 13 Plan over a maximum five-year time period.
That being said, a person facing foreclosure must be realistic as to his/her ability to maintain regular monthly mortgage payments in addition to making a monthly payment to the Chapter 13 Trustee. The regular monthly mortgage payment cannot be altered by the Court in Chapter 13, though the debtor is free to seek a modification of the mortgage from the lender.
2. Removing (“Stripping”) A Second Mortgage. Under certain circumstances, Chapter 13 can be used to “strip” a second mortgage from the debtor’s residence. In order to strip a second mortgage, the value of the home must be less than the amount owed on the first mortgage. If there is even $1 of equity to support the second mortgage, it cannot be stripped.
Keep in mind that if there is only a small difference between the value of the home and the amount owed on the second mortgage, the second mortgage holder may object to the debtor’s attempt to strip the second mortgage. The debtor will then likely have to pay for an appraisal of the home, and litigate the matter in Court. In addition, if the Chapter 13 case is dismissed or converted to Chapter 7, the second mortgage will be reinstated against the property.
3. Payment of Back Taxes or Child/Spousal Support. As discussed in one of our previous posts, most tax debt is not dischargeable in bankruptcy. Child and spousal support is never dischargeable. A debtor facing garnishment for non-dischargeable back taxes or back child/spousal support can use Chapter 13 to pay that debt through the Chapter 13 Plan. The garnishment for that debt will stop. It is important to realize, however, in cases involving back child or spousal support, the debtor must maintain regular monthly support payments after the bankruptcy case is filed. Judges will quickly dismiss Chapter 13 cases if they are not.
4. Protection of Property That Would Be Forfeited in Chapter 7. As discussed above, a Chapter 7 debtor will lose any property that is not considered “exempt” under the law. A debtor with non-exempt property can file a Chapter 13 case to protect that property. In Chapter 13, the debtor must pay unsecured creditors (over the life of the Plan) the same amount of money as they would have received had the property been taken and sold by a Chapter 7 Trustee.
5. Reduction In Amount Owed On Vehicle Loans (“Cram-Down”). In certain circumstances, Chapter 13 can be used to reduce the amount owing on a vehicle loan. If the vehicle was purchased more than 2½ years before the filing of a Chapter 13 filing, the loan balance can be reduced to the value of the vehicle, and paid as part of the Chapter 13 Plan. For obvious reasons, this is known as a “cram-down”. The interest rate on the loan as reduced can often be lowered to 4%.
6. Discharge of Non-Support Debt Incurred in a Divorce Decree. Non-support debt incurred as part of a divorce proceeding can be discharged in Chapter 13. This type of debt usually involves a judgment for property settlement as part of the divorce decree (sometimes called an “equalizing distribution” or “equalizing judgment”). Note that even if the divorce decree states that a particular debt is one for property settlement, if it is really one for support, it cannot be discharged. Case law has repeatedly held that the bankruptcy court has the independent authority to determine the true nature of the debt involved, notwithstanding the labels attached by the parties to the divorce case.
This post is intended to be purely informational in nature, and cannot be considered legal advice. If you have questions related to the advantages of Chapter 13 Bankruptcy or other bankruptcy issues, please call our office at (503) 545-1061 (Oregon cases) or (360) 836-4238 (Washington cases) to schedule a free initial consultation.