Chapter 13 bankruptcy: What you need to know

Chapter 13 bankruptcy filings hit their highest level in 2010 when they reached 434,739 non-business filings. Filings declined significantly during the COVID-19 pandemic but have begun to rise again as of 2022.

Because filing bankruptcy has long-term financial consequences, you should understand how Chapter 13 works before any official proceedings take place.

What Chapter 13 bankruptcy is and how it works

Chapter 13 bankruptcy, also called a reorganization, is a legal process that allows you to restructure your debt to be more manageable based on your finances.

With the help of an attorney, you file a petition for Chapter 13 with a bankruptcy court. Although you’re not required to hire an attorney, their knowledge may help your chances of success.

In addition to filing, you will submit a proposal for repaying your creditors over time. With the help of the court, you and your creditors will design a repayment plan that lasts from three to five years.

Once the judge approves your proposal, you will send monthly payments to a court-appointed trustee. They will collect and distribute your payments to your creditors for the duration of your agreement. After, any remaining debts are discharged.

Advantages of filing for Chapter 13 bankruptcy

While bankruptcy will stay on your credit report for up to seven years, there are multiple reasons you may want to choose Chapter 13 over other options.

• You may be able to keep your home. Chapter 13 can allow a debtor behind on mortgage payments and facing foreclosure to catch up on payments, reinstate the mortgage and stay in the home.
• Co-signers may not be held responsible legally. A section of Chapter 13 law known as the “co-debtor stay” prevents creditors from going after anyone who co-signed for you on a debt.
• You have a right to sell your property. Because you have made arrangements to repay your creditors, you are free to sell your property at a time when it will generate the greatest value.
• You can keep your business up and running. If you are a sole proprietor, Chapter 13 allows you to continue to do business. It is important to remember that your business must produce enough income to help you make monthly Chapter 13 payments.
• Your debt is frozen. All debt on unsecured claims are frozen the day you file for Chapter 13. This means payments you make to your creditors are used to pay down debt rather than being eaten up by interest and late fees.

Who should file for Chapter 13

Chapter 13 bankruptcy is designed for people who have a consistent source of income, even if it isn’t enough to cover their debts. If you have a solid job or way to make money, but simply can’t afford to fully pay what you owe, Chapter 13 may be a good option. It lets you maintain more control over your finances and assets than you would with a Chapter 7 bankruptcy, which forces you to sell most of your assets.

Declaring bankruptcy in any form has massive financial consequences. You give up some level of control over your finances in exchange for help getting out of debt. A Chapter 13 bankruptcy typically stays on your credit reports for seven years from the date you filed the petition. It can lower your credit score by around 130 to 200 points, but the effects on your credit diminish over time.

While you repair your credit, it may be hard to qualify for new loans or other forms of credit. There’s also pressure to keep up with your three- to five-year plan because missing payments could lead to a dismissal. In that case, you stand to lose any assets you were trying to protect. Because of this, Chapter 13 bankruptcy should be used as a last resort.

How to file for Chapter 13

If you are considering Chapter 13 bankruptcy, it helps to know whether you might qualify and the steps involved. The process can take three to four months before you finalize the repayment plan, but payments may start in as few as 30 days.

Prerequisites

When you file for Chapter 13 bankruptcy, you’ll need to meet certain requirements. The court will check your income, tax status, debts and previous bankruptcies to determine if you qualify.

• You earn a regular income. If your income is lower than the median level in your state, then you’ll repay your debt over three years. The court may allow you to repay your debt over five years if your income exceeds the state median.
• You are not behind on taxes. The court may ask to see several years’ worth of filed tax returns. Federal taxes are unlikely to be discharged with a bankruptcy, so speak with your attorney if you owe money on taxes within the last three years.
• Your debts do not exceed the limit. To file for Chapter 13 as an individual, your combined secured and unsecured debts total less than $2.75 million.
• Sufficient time has passed since your last filing. You may not receive a discharge if you filed for bankruptcy recently. You must wait two years to file for Chapter 13 and four years if you filed for Chapter 7.

Steps for filing Chapter 13

There are several steps you must take to prepare for bankruptcy and correctly file your petition. An attorney can help you navigate these steps so you can eventually complete your repayment plan.

1. Find an approved credit counselor to help you weigh your options. If you decide to move forward with bankruptcy, you can hire a bankruptcy attorney to help you fill out the paperwork.
2. File a bankruptcy petition with your local bankruptcy court along with $313 in fees and a payment proposal that explains how you plan to repay your creditors.
3. Meet your court-appointed trustee who will review your case and organize your creditor meeting. At the meeting, you will answer questions about your debt and the proposed plan.
4. Attend a confirmation hearing where a judge will review your petition and decide if you have the means to follow through with your proposal. Based on that decision, you will either move forward with Chapter 13, modify the plan or file Chapter 7 bankruptcy instead.
5. Follow the repayment plan over three to five years. Your trustee will collect and distribute payments during this time. Once you’re done with repayment, the bankruptcy case will be discharged.

Alternatives to Chapter 13

Chapter 13 is not the only option. If you’re struggling with paying your bills and fielding calls from debt collectors, talking with a credit counselor will help. They can help you look over your budget and debts, then make a plan to work towards becoming debt free.

You can also look into debt relief companies ahead of filing for bankruptcy. There are still likely going to be credit consequences to working with one and they require fees, but a good debt relief company will help you navigate creditor repayment.

Debt consolidation is a strategy that a credit counselor or debt relief company might propose. However, to get the best debt consolidation loan rates, you need to have credit that’s in fairly good shape. If your credit has already taken a hit from falling behind on payments, it may not be the best option.

Chapter 7

Chapter 7 can also provide relief from creditors — without forcing you to make monthly payments. As part of a Chapter 7 bankruptcy, nearly all of your debt is erased or discharged.

In order to discharge debt under Chapter 7 bankruptcy, however, nonexempt personal property of value is sold. A court-appointed trustee takes charge of liquidating or selling some of your possessions in order to repay creditors. The money earned from the sale of your items is used to repay creditors. Any remaining debt will be discharged, with the exception of student loans, child support, taxes and alimony.

Chapter 7 may be a good choice for those who do not have the ability to repay debts through a reorganization plan. In order to qualify for Chapter 7, you will typically have to undergo a means test to confirm that you truly do not have the financial resources to pay back outstanding debts.

The bottom line

Chapter 13 might be the right solution to help you get your finances back on track. Look for a reputable bankruptcy lawyer and check whether you qualify for free legal services.