What is Chapter 13 bankruptcy?

Chapter 13 bankruptcy is a legal process that allows people to repay their debts over time while having the opportunity to keep valuable assets, like a home.

Chapter 13 bankruptcy is also called the “wage earner’s plan,” because those who file need regular income to qualify. Instead of having your debt forgiven, you’ll restructure your debt with a three- to five-year repayment plan.

The flexibility of the repayment plan can make Chapter 13 the right kind of bankruptcy for those who have a job with steady income and want to hold onto their property.

Here’s a rundown of who’s eligible for Chapter 13, the general shape of the process, and the pros and cons to consider before filing.

• Who is eligible for Chapter 13 bankruptcy?
• Repaying debts in Chapter 13 bankruptcy
• The Chapter 13 process
• Benefits to filing Chapter 13 bankruptcy
• Drawbacks to filing Chapter 13 bankruptcy

Who is eligible for Chapter 13 bankruptcy?

Anyone with regular income can file for Chapter 13 bankruptcy, as long as the total debt is within the threshold. The individual’s income level helps determine the timeline of the repayment plan.

If your income exceeds the median level in your state, you’ll repay your debts over five years. If your income is below the median, repayment will take place over three years.

Here are some things to consider if you are thinking about filing for Chapter 13.

• Regular income is required.
• You must provide up-to-date tax returns and payments.
• Unsecured debts, like those from unsecured credit cards and personal loans, can’t exceed $394,725. Secured debt — for example, from a mortgage or car loan — can’t exceed $1,184,200.
• You may not qualify if you’ve had a bankruptcy dismissed within 180 days for a failure to appear in or comply with the bankruptcy court.
• To receive a discharge at the end of a Chapter 13 repayment plan, you can’t have received a discharge from a Chapter 13 bankruptcy within the previous two years or from a Chapter 7, Chapter 11 and Chapter 12 within the previous four years.

Repaying debts in Chapter 13 bankruptcy

Debtors can set their own repayment plans in Chapter 13 — with the approval of the court. The plan is a central part of Chapter 13 bankruptcy, and it’s written out on either a federal form or one from a local court. The plan describes …

• Your trustee and how much that person will get paid each month.
• How you’ll get the money to the trustee.
• How long the plan will last.

Not all debt will be repaid, and it will generally fall into three categories.

• Priority debt — such as student loans, child support and most tax obligations — generally must be paid in full.
• Secured debt — such as a mortgage or car loan — will ultimately be paid back over time. Any missed payments can be brought current as well.
• Payments toward unsecured debt — such as outstanding credit card balances — are flexible. They might be reduced, and remaining balances may even be forgiven once the repayment plan is completed.

By stretching out repayment over several years, Chapter 13 bankruptcy can make debt more manageable and allow filers the opportunity to save valuable property like a home or automobile from foreclosure or repossession.

The Chapter 13 process

The Chapter 13 filing process generally takes 95 days from the filing of the petition to the approval of the repayment plan. But the bankruptcy won’t actually be discharged until the three- to five-year plan is completed.

Here’s what to expect over a typical Chapter 13 bankruptcy proceeding.

1. Complete credit counseling from an approved agency — within 180 days before filing.
2. An attorney can help with preparing the paperwork, which includes …

• A list of creditors and how much is owed to each
• Evidence of income
• A list of property and valuables
• A recent tax return
• A description of your living expenses
• A certificate of completion for the credit counseling course

3. File a bankruptcy petition, which includes $310 in fees, with the local bankruptcy court. This will put a temporary pause on any debt obligations. Foreclosure proceedings and most debt collection attempts will stop until the repayment plan is complete.
4. Submit a repayment plan within 14 days of filing the petition. The plan describes how lenders will be repaid.
5. Start following the repayment plan within 30 days after filing the bankruptcy case, even if the court hasn’t approved it yet.
6. The court will assign a trustee, who will review the case and meet with creditors.
7. The trustee will set up a creditor meeting between 21 and 50 days after you file the petition. At the meeting, you’ll answer questions under oath about your debt and proposed plan.
8. Attend a confirmation hearing within 45 days after the creditor meeting. At the hearing, a judge will decide on whether to approve the plan. If the plan doesn’t meet standards, you can try to modify the plan or convert the filing to a Chapter 7 bankruptcy.
9. Follow the repayment plan over three to five years. The trustee will collect and distribute payments throughout this time.
10. The bankruptcy will be discharged after the repayment plan is fulfilled and you’ve taken a debtor education course from an approved agency, and you’ve met all other requirements.

Benefits to filing Chapter 13 bankruptcy

There are some advantages to filing for Chapter 13 instead of Chapter 7 — and advantages to filing for Chapter 13 versus not filing bankruptcy at all.

Keep the house

Homeowners who are behind on mortgage payments can have the chance to gradually catch up on those debts and potentially save their homes from foreclosure.

Consolidate payments

By sending one monthly check to a trustee and allowing that person to pay the lenders, debts are consolidated. Depending on what you negotiate with the creditor, the payments may be lowered, too.

Looks better on credit reports

Although the debt won’t be repaid per the original terms, most or all of the debt is repaid under Chapter 13. Therefore, it will stay on your credit reports for seven years. A Chapter 7 bankruptcy, on the other hand, remains on credit reports for 10 years.

Co-signers may be protected

Unless authorized by the bankruptcy court, creditors may not seek to collect debt from a “co-debtor,” which could be a relief for those who agreed to help shoulder liability.

Drawbacks to filing Chapter 13 bankruptcy

Although Chapter 13 can help when you’re in a financial pinch, it does have its disadvantages.

Your credit will take a hit

Bankruptcy can have a more severe negative affect on your credit than mere missed payments. A Chapter 13 bankruptcy will appear on your credit reports as a derogatory mark for seven years from the date you filed the petition. The number of points your credit scores will drop will vary depending on your current scores and other factors relating to your financial situation. For more on this, check out our article on how to build credit after a bankruptcy.

It may be difficult to qualify for new credit

Because of those lower credit scores, you might have trouble with situations that require a credit check: getting a job, applying for an apartment rental or otherwise. Interest rates and fees on loans will typically be higher, too.

No second chances

There’s extra pressure to keep up with payments over the three to five years of the plan. Although you may get a chance to modify the plan, missing payments could lead to a dismissal. If that occurs, you stand to lose any assets you were trying to protect.

“You have to be prepared to keep up with that obligation,” says Kevin Gallegos, vice president of new client enrollment at Freedom Debt Relief. “And if you don’t, there’s not a whole lot of recourse after that.”

Bottom line

Bankruptcy is a serious financial measure, but it might be an option for people struggling with debt. Chapter 13 bankruptcy could make sense if you have steady income and want a chance to keep your home or car. If you’re considering it, a credit counselor and attorney can help you weigh the pros and cons of filing for your specific situation.

If you decide Chapter 13 is right for you, then make sure you can keep up with your repayment plan. If you can’t, then you could lose the assets you were trying to protect. There’s no guarantee the immediate relief will be worth the long-term consequences of the bankruptcy.