What is Chapter 13 Bankruptcy?

Chapter 13 bankruptcy is one of two options available to individual debtors, but it is drastically different than Chapter 7 bankruptcy. Think of Chapter 13 bankruptcy as a federally approved consolidation plan that allows a debtor to make a single payment each month that is divided up by the Bankruptcy Trustee among all creditors. There are generally fewer restrictions and complications with Chapter 13 bankruptcy. For example, there are no income guidelines to deal with, unlike Chapter 7 bankruptcy. Also, the complicated Means Test that can come into play for some Chapter 7 filers has no applicability in a Chapter 13 case.

Generally speaking, there are three primary reasons that a debtor would choose Chapter 13 over Chapter 7 bankruptcy, which is favored by about 70 percent of all individual bankruptcy filers in the country:

• A sense of duty to repay creditors. Some debtors are uncomfortable with the idea of the Chapter 7 liquidation that allows someone to walk away from virtually all unsecured debt. By turning to a Chapter 13 filing, the debtor pays any disposable income to creditors, usually for 5 years.
• An effort to stop a home foreclosure. The automatic stay that comes with the Chapter 13 filing can be followed a proposed repayment plan that takes care of back-due mortgage or vehicle payments over what is usually a 5-year period. The plan is usually embraced by creditors, who could risk getting nothing from a debtor.
• Too much income. A debtor who earns more than the median salary for people in his state, and who has more than $167 in monthly disposable income after comparing income and expenses, does not qualify for Chapter 7. The so-called Means Test that compares income and expenses is a new facet of bankruptcy law introduced in 2005. The goal is for debtors with a steady flow of income and at least some disposable income to repay as much of what they owe to creditors as possible.

While Chapter 13 is generally simpler and easier to qualify for than Chapter 7, it still poses some risk to debtors. Of the 30 percent of individual debtors who chose a Chapter 13 repayment plan, only 1 in 3 ever finish the plan. As soon as a debtor is unable to complete a Chapter 13 repayment plan, the case is discharged and the automatic stay that provided a shield against creditors is lifted.

Also, fraudulent Chapter 13 filers can really put themselves in a difficult situation. For many Chapter 7 filers who lie to Bankruptcy Trustees in their detailed bankruptcy petitions most have the option to turn to Chapter 13. But when the court exposes fraud perpetrated by a Chapter 13 filer, there are often no alternatives. The debtor often cannot turn to Chapter 7 because of high income - or else he would have filed under Chapter 7 in the first place. That means cases dismissed for fraud leave a debtor with no bankruptcy alternatives at all.