Depending on your profile of debts, assets, and income, Chapter 13 can offer unique opportunities that may just outweight its inherent disadvantages.
Chapter 13 is almost always a longer and more expensive process than Chapter 7. So those whose primary problem is unsecured debt — credit cards, medical bills, charge accounts, or finance company loans — will usually find Chapter 7 preferable. But certain features of a debtor’s financial pattern can make Chapter 13 quite appealing.
1. A mortgage default. Traditionally most Chapter 13’s are filed by people who are behind on their mortgages and fear they cannot catch up before the home is lost to foreclosure. Chapter 13 can prevent foreclosure or even stop a pending foreclosure, allowing the debtor to cure the past arrearage by payments over as much as five years while maintaining the future payments directly to the mortgage servicer. However, the debtor must be able to afford the future payments required by the note and mortgage.
2. Problem nondischargeable debts. A debtor cannot discharge past-due domestic support payments or most kinds of delinquent taxes in any form of bankruptcy. And these creditors can have crippling remedies against the debtor, including liens, wage garnishment, and even jail. But Chapter 13 puts these threats on hold and lets the debtor pay the delinquency over several years — far longer than he could usually negotiate with a former spouse or the IRS.
3. Underwater secured debts. Chapter 13 can often reduce the amount the debtor must pay on secured debts where the collateral is worth less than the amount of the debt. If an auto loan is “upside down” and over 2-1/2 years old, for example, the debtor can satisfy the lien on the vehicle by paying the creditor its value instead of the sometimes much higher loan balance. In addition, if the debtor’s home is worth less than the balance on the first mortgage, he can treat a second mortgage (including a home equity line) as unsecured– satisfying it in full with no separate payment, as if it were a normal unsecured debt.
4. Non-exempt assets. In Chapter 13, unlike Chapter 7, the trustee does not seek to sell off any of the debtor’s property. So if the debtor has non-exempt equity in any asset, he might prevent a trustee from selling the asset by filing Chapter 13 and paying his creditors an equivalent value. For example, in South Carolina, where the motor vehicle exemption is $5,625, a car worth $10,000 more than the loan against it could have almost $4,400 of non-exempt equity. A Chapter 7 trustee would likely sell the car, but a Chapter 13 debtor could usually pay his creditors $4,400 over several years and avoid that loss. For most individuals, this strategy can be a side benefit but is rarely an adequate reason by itself to switch from Chapter 7 to Chapter 13.
5. Disposable income. Especially since changes enacted in 2005, the Bankruptcy Code can disqualify individuals from filing Chapter 7 if they can afford to pay a meaningful part of their unsecured debt over time. For these people, Chapter 13 can provide a way to wipe out unsecured debt that usually requires paying only a small percentage of the principal and no interest at all (a colleague calls this a “postage stamp 13”). And in some situations the calculation of disposable income is more favorable in Chapter 13 than in Chapter 7.
Like any decision on bankruptcy strategy, the choice of which chapter to file is not as simple as this makes it sound. While it is sometimes possible to convert from one chapter to another, that can be expensive and time-consuming. Consulting an experienced bankruptcy attorney is an inexpensive and vital step you should take before you decide.