The most basic definition of “chapter 13” is that it is that chapter in the Federal Bankruptcy Code that allows a debtor to pay back all or at least a part of his or her debts under the supervision of the Bankruptcy Court.
Of course, as with most legal matters, the question of what it is can be much more complicated than where it is located in a book.
Let’s start with the statement above then….restated:
When a debtor files a chapter 13 bankruptcy, he or she is proposing a plan to deal with his or her debts and assets in a manner that will allow the debtor to reorganize his or situation for the better. In order to do so, this plan must propose a number of things by law.
Typically the most importantthree are these:
1. Pay Debt – which debts will be paid during the plan by the debtor;
2. Protect or Surrender Non-Exempt Assets – Which assets will be paid for, protected or surrendered and;
3. Discharge Debt – which debts will be wiped away at the end of the plan
These proposals are more fully explained as follows:
1. Pay Debt
a. The plan must propose to pay all “priority” debt as defined by the Bankruptcy Code. This includes debts like child support, spousal maintenance, and newer income tax debt.
b. The plan must propose to pay all arrears on the home the debtor wishes to keep. The “arrears” are the reason the home lender is threatening foreclosure. The debtor is behind.
c. The plan must propose to pay the car loan(s) over the course of the plan, through the plan i.e. directly to the bankruptcy trustee who pays the car lender.
d. The plan must pay some amount as a fee to the Chapter 13 bankruptcy trustee.
e. The plan must pay unsecured creditors the greater of the following to amounts divided over the length of the plan:
– The value of the Debtor’s assets that aren’t protected by State Law or the non-exempt assets.
– The amount that the bankruptcy code’s testing provisions determine that the debtor can afford to pay above his or her allowable living expenses, including the normal mortgage payment.
There are other debts, like student loans that are not necessarily priority debt, but that may not be “discharged” at the end of the plan OR paid in full during the plan. Strange, I know.
2. Protect or Surrender Non Exempt Assets
a. Non-exempt assets as stated above must be either surrendered to the chapter 13 trustee for liquidation and payment to unsecured creditors, or their value must be paid to unsecured creditors over the length of the plan.
3. Discharge Debt
a. All remaining unsecured and non-priority debt not exempted from discharge by law is wiped away at the end of the plan. i.e. all remaining credit card, medical bill, personal loan, qualifying income tax etc.
b. All remaining “stripped off debt”. Under current chapter 13 bankruptcy law, the debtor may be able to strip down a car loan or a second mortgage if these loans meet certain criteria.
If a car, for instance, was purchased more than 2.5 years before the bankruptcy filing and is worth less than what the bank is owed, the chapter 13 debtor only has to pay the value of the car through plan. The remainder is treated as an unsecured, non-priority and dischargeable debt and “wiped away” at the end of the plan.
c. Debt related to assets that the debtor chose to surrender to the creditor. i.e. car, 4 wheeler, second home, etc. that the debtor wants to give up.
This plan proposal may be best understood by looking at an actual example.
I am providing, therefore, the following information about the fictional “Mr. and Mrs. Field” along with how a chapter 13 bankruptcy may be able to alter that situation.
First some background about the Field family:
Mr. and Mrs. Field own the following assets:
1. Single Family Home – $275,000 Value 2. 1998 Toyota Corolla – $2300.00 value 3. 2004 Honda Minivan – $18000.00 value 4. Art Collection – $7,000.00 value (left to them via grandparent estate not exempt or would be lost to creditor in a chapter 7)
5. Household Furnishings – $8000.00 6. Clothing – $1000.00 7. Wedding Bands – Engagement – $2000.00 8. 401k – $45000.00
Mr. and Mrs. Field have the following debt:
1. Honda Finance – $23,000.00 2. GMAC First Mortgage – $275,000.00 3. Beneficial Second Mortgage $40,000.00 4. Credit Card Debt accumulated over 5 year period – $65,000.00 5. Medical bill debt accumulated during period uninsured – $25,000.00 6. Income Tax Debt – $2200.00 – accidental underwithholding after raise at work
Mr. and Mrs. Field have two children and Mrs. Field works as a homemaker. Mr. Field works for a Software Developer and is paid a gross salary of $6400.00 per month. Their monthly budget is currently as follows:
$950.00 state, federal and payroll tax withholding $350.00 health insurance withheld from check $1800.00 First Mortgage payment with Tax and Insurance – they are $7500.00 in arrears.
$350.00 Second Mortgage $300.00 Honda payment $150.00 Clothing
$800.00 food and personal $425.00 utilities $100.00 out of pocket medical expense $175.00 Term and Auto Insurance $600.00 gas, upkeep, registration car expense $300.00 401k plan contribution
The amount of the Field’s basic budget is $6300.00 per month total.
They need to pay more than $3000 per month to service their unsecured credit card and medical bill debt. The total budget amount is therefore at least $9300.00 per month if they were paying the full amount.
How a chapter 13 bankruptcy may help:
If the Fields filed a chapter 13 bankruptcy , their new household budget would be as follows:
$950.00 state, federal and payroll tax withholding $350.00 health insurance withheld from check $1800.00 First Mortgage payment with Tax and Insurance – they are $7500.00 in arrears.
$150.00 Clothing
$800.00 food and personal $425.00 utilities $100.00 out of pocket medical expense $175.00 Term and Auto Insurance $600.00 gas, upkeep, registration car expense $300.00 401k plan contribution
$5650.00 per month
The Field’s Chapter 13 Plan would look something like this:
The plan would be 60 months long. (The length of the plan is the subject of another post)
The plan payment would be $750.00 per month for a total payment over 60 months of $45000.00
This amount sounds very high until the items that are paid in the plan are reviewed.
The plan payment total would be used to pay roughly the following debt and fees:
$7500.00 house arrears, stopping any foreclosure activity $18000.00 to pay off the Honda as it was purchased more then 2.5 years prior
$2200.00 in interest and fees on the car and the arrears $4500.00 bankruptcy trustee fee $3500.00 attorney fee
$2200.00 priority tax debt
$37900 total
$7100.00 or the remainder would be paid to the unsecured creditors and would thereby protect the Field’s Art Collection.
Who are the unsecured creditors again?
1. $5000.00 – Honda Finance difference between owed and value of car 2. $40,000.- The Field’s Second Mortgage stripped away bc it was wholly unsecured 3. $65,000.00 Credit Card Debt accumulated over 5 year period
4. $25,000.00 Medical bill debt accumulated during period uninsured
$135,000.00 in total unsecured debt. This pool of creditors would receive $7100.00 or about 1/19th of the debt.
The benefits to Mr. and Mrs. Field of the Chapter 13 filing:
1. Reduce unsecured debt by $127,900 2. Pay off Tax Debt 3. Catch up Home Mortgage and save from foreclosure.
4. Pay off car loan at a reduced amount
Chapter 13 Bankruptcy works for thousands of Arizonans each year. It works especially for those with a steady income, and a desire to live by a budget. It must work for those who don’t qualify for a chapter 7 bankruptcy and who do not have the assets to “settle” the debt.
