Chapter 13 Bankruptcy: How Does it Work?
11 MIN READ
Published September 01, 2023 | Updated December 10, 2023
Most people think of bankruptcy as a process in which they lose their assets and erase their debts. While that is true for some bankruptcy cases, Chapter 13 bankruptcy works differently. It doesn’t erase all of your debts, but you’ll be able to keep your assets and pay part of your debts through a repayment plan.
If you’re facing financial difficulties and are considering bankruptcy, it’s important to consider long-term implications, qualification requirements, and alternatives that you may want to explore before filing for Chapter 13 bankruptcy.
What is Chapter 13 Bankruptcy
Chapter 13 bankruptcy is a legal proceeding that allows you to restructure and then repay your debts over a period of three to five years while having the opportunity to retain valuable assets. Chapter 13 is also known as reorganization bankruptcy or wage earner’s plan because you’ll need to have regular monthly income to be eligible to file. The court won’t forgive all your debt, but you’ll be able to pay some of it through a repayment plan, and the court will forgive the rest of it.
How Does it Work
Here’s a quick look at how Chapter 13 bankruptcy works from start to finish. Once you review these steps, you’ll have a better understanding of whether this is the right option for you.
1. Complete the Credit Counseling Course
You’ll need to attend a credit counseling course from a nonprofit credit counseling agency that has been pre-approved by the U.S. Bankruptcy Courts. The course will help you understand if you have sufficient income to qualify for bankruptcy and whether it might be possible for you to regain financial footing without bankruptcy. It will also help you develop a feasible repayment plan.
2. File Your Paperwork
If you’re working with a bankruptcy attorney, they’ll help you file the right paperwork and guide you on the documents you’ll need to submit with your bankruptcy petition. You’ll need to pay a bankruptcy filing fee of $313 when you file your paperwork. Once you do that, the court will send you information about the trustee for your case and information about the 341 meeting you must attend.
3. Attend the Meeting of Creditors (aka, the 341 Meeting)
All filers are required to attend the 341 meeting of creditors, where the trustee will verify your information, ask you questions, and review your bankruptcy paperwork. Creditors can also attend the meeting to learn more about the case, but they rarely do. At least five days before the meeting, you’ll need to submit your 521 documents, which include paystubs, tax returns, and bank statements. (“521” refers to the relevant section of the bankruptcy code that applies to these required supporting documents.)
4. Start Making Your Payments
Once the court reviews your proposed repayment plan and approves it, you’ll start making the monthly payments. In many cases, you may need to start making payments even before the court confirms the proposed plan. Your creditors will also have the opportunity to object to the proposed repayment plan. If there are oppositions from your creditors, your attorney will make changes to the plan to everyone’s satisfaction and present it during the confirmation hearing.
5. Complete the Chapter 13 Repayment Plan
You must make the necessary payments as per the repayment plan and complete the debtor’s education course before the court will order a debt discharge, which will wipe out your remaining qualifying debts. Once you receive the bankruptcy discharge, you’ll be free of debt, except student loans, car loans, and mortgage debt.
Impact on Credit Scores
Filing bankruptcy will continue to impact your credit score as long as it stays on your credit report, which is a minimum of seven years, but may be as long as ten years, depending on what your creditors continue to report to your credit files. But, if you don’t have any other financial difficulties along the way, this negative impact will lessen over time. Chapter 13 doesn’t have as severe an impact on your credit because you’ll be paying some or most of your debts through your creditor-approved Chapter 13 repayment plan.
Impact on Future Financial Stability
When you file for bankruptcy, the impact on your credit score has long-term consequences. First, the lower credit score will make it difficult for you to obtain new credit. Lenders may not be as willing to extend credit to you if bankruptcy is reflected anywhere on your profile. If you do get credit, the interest rates you’ll qualify for will be much higher, making it very expensive for you to borrow. Additionally, it may be difficult for you to rent an apartment, apply for a new job, or anything else that involves a credit check.
Are You Eligible?
There are several qualification criteria that you must be able to satisfy before you can file for Chapter 13. This will determine if you’re eligible and how much you may have to pay as part of your repayment plan.
Income Requirements for Chapter 13 Bankruptcy
An important eligibility requirement for Chapter 13 bankruptcy is a regular source of income. You must demonstrate that you’ll be able to afford the monthly plan payment along with your living expenses. If your income is too low, or if you don’t have regular income, the bankruptcy court will not approve your repayment plan.
Debt Limits for Chapter 13 Bankruptcy
You’ll only be eligible for Chapter 13 bankruptcy if your combined total unsecured and secured debts are less than $2,750,000 on the date you file for bankruptcy. The court no longer limits debts in categories like unsecured debt and secured debt.
Other than the income and debt limit criteria, you must also be current on your tax filings in the last four years. You must not have received a discharge from Chapter 13 bankruptcy in the last two years or Chapter 7 bankruptcy in the last four years. If you filed for bankruptcy in the past, but the court dismissed your petition, you must wait 180 days before you can file again. Additionally, you must complete the mandatory credit counseling course before you’ll be eligible to file for bankruptcy.
Pros and Cons of Chapter 13 Bankruptcy
Chapter 13 bankruptcy can provide you with the structure and breathing room you need to catch up with your debts while protecting your assets. But it may not be the right option for everyone. Review the pros and cons listed below before you make your decision.
Pros of Chapter 13 Bankruptcy
- Chapter 13 bankruptcy gives you the opportunity to catch up with mortgage payments and car loans, so you may be able to avoid foreclosure and repossession.
- You’ll be sending one payment each month to the bankruptcy trustee, who will then pay all your lenders. This will streamline your payments and make it easier for you to repay debts.
- As soon as you file for bankruptcy, the court will issue an automatic stay. This means that your lenders will no longer be able to pursue collection efforts. Existing wage garnishments will stop, too.
- Creditors cannot try to collect debt from co-signers either, unless the bankruptcy court authorizes it.
Cons of Chapter 13 Bankruptcy
- Chapter 13 bankruptcy will stay on your credit report for a minimum of seven years, after which, it is possible that some of the residual negative credit information reported by your creditors during those seven years may remain on your credit reports for 1-3 years after that, stretching it to as long as ten years. You will notice that your credit scores on all three of your credit reports will drop substantially, within a very short time (within 30 days) after you file your bankruptcy petition.
- It may be difficult for you to qualify for a new apartment leasel or to get any kind of new credit extended to you. Interest rates on any new debt you may qualify for will certainly be much higher, too.
- It may make getting a new job difficult if it requires a credit check.
- You’ll need to make monthly payments without fail. If you miss a payment, the court can dismiss your case.
How is Chapter 13 Bankruptcy Different from Chapter 7
The major difference between Chapter 7 vs. Chapter 13 bankruptcy is the repayment plan. In Chapter 13 bankruptcy, you’ll need to pay off all or at least some portion of your debts through a court-approved repayment plan. Secured creditors usually get enough to cover the value of the collateral. Unsecured creditors are a second priority and may get a little through the repayment plan, or they may end up receiving nothing.
Chapter 7 bankruptcy, also known as liquidation bankruptcy, doesn’t involve a repayment plan. Instead, some of your assets are placed into trust with a trustee and then sold off. The proceeds are then used to pay off your lenders. The court will wipe out the rest of the debt. Qualifying for Chapter 7 is harder because you’ll have to pass a means test. But if you have a low disposable income or no income, you may be able to qualify.
Finding a Bankruptcy Lawyer
Bankruptcy is a complex process, and it’s best to work with a competent and experienced bankruptcy attorney. To find the right lawyer, you’ll need to begin by researching and vetting candidates. It is very likely you’ll also need to consult with a handful of lawyers before you can retain one that you’re comfortable working with.
Researching Bankruptcy Lawyers and Law Firms
While you’ll be able to find several bankruptcy lawyers in your area through a simple online search, it’s important to be discerning about who you decide to work with. Start your search on the National Association of Consumer Bankruptcy Attorneys and The American Bar Association. Always read reviews of law firms and check the credentials of the lawyers you shortlist.
Most lawyers offer free initial consultation. Contact a few qualified attorneys and set up an initial consultation with each. This initial consultation will help you decide if you feel comfortable working with them and if they have the expertise to help you. Ask if they have specialized background or training. Many lawyers have a bankruptcy certification or are affiliated with NACBA, so they may have a better understanding of the bankruptcy code.
Recent Updates to Chapter 13 Bankruptcy Laws and Regulations
Bankruptcy laws and regulations are not always stagnant. Knowing the recent changes to the laws can help you make more informed decisions. Whether you’re working on your own or with a bankruptcy lawyer, staying informed about the current regulations is always a good idea.
Changes to Chapter 13 Bankruptcy Laws and Regulations
The Coronavirus Aid, Relief, and Economic Security Act (CARES) was introduced in March 2020. The act included many provisions related to bankruptcies. However, the provisions of the CARES Act expired in March 2022 and have not been extended.
The act allowed those filing for Chapter 13 bankruptcy to modify their payment plan if they could demonstrate financial hardship. Debtors were also allowed to extend the repayment plan up to 84 months. If you had filed for Chapter 13 bankruptcy while the act was in effect, some of these provisions may still be in effect for you.
Alternatives to Chapter 13 Bankruptcy
Bankruptcy may resolve your debt, but you should consider it your last option. Look for debt relief alternatives that may help you manage your debt better while minimizing the damage. Debt consolidation and debt settlement are two possibilities.
If you have multiple debts, a debt consolidation loan will allow you to streamline your payments and lower your interest cost. If your credit score allows you to qualify for a lower interest rate than what you’re paying on your current debts, debt consolidation can offer you substantial savings.
Debt settlement involves negotiating with your lenders to reduce what you owe and settling your account with a lump sum payment, which may end up being as little as 50%-60% of your current balance. You can also hire a debt settlement company to handle negotiations on your behalf. If you’re already behind on payments, your lenders may be more likely to accept your settlement offer, and you may be able to save as much as 50% of your original debt before fees.
Filing Chapter 13 bankruptcy is not an easy decision, but it can provide you the relief you need from collection calls and unpaid bills while allowing you to keep your assets so you can get a fresh start. Although bankruptcy will stay on your credit report for several years, you can start making timely payments and get a secured credit card to begin rebuilding your credit.