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Posted by: Rob Cohen
After all, who wants to be in bankruptcy for 3-5 years as is required in a chapter 13 case? At first blush, it certainly sounds like a raw deal.
Very often I will sit down with a new consult and one of the first things they say is “I want this to be a Chapter 7 bankruptcy, I don’t want Chapter 13.”
I always then ask “Why do you say that?” because the answer gives me insight into what they have already learned (either through reading or talking to someone else, which is often wrong) and what kind of result they are looking for. Very often, these same folks end up being excited about the idea of going through a Chapter 13 bankruptcy.
It’s been awhile since we discussed the advantages of Chapter 13 bankruptcy here on the forum, so I thought I’d dust off the list in the hopes of raising the spirits of those facing bankruptcy.
Advantages of Chapter 13 Bankruptcy
A Chapter 13 bankruptcy has a few main advantages, namely dealing with your property and tax debt.
Let’s take a look at each.
Help with Foreclosure
The first, and most commonly known, benefit of Chapter 13 is its ability to save a home from foreclosure. Under normal circumstances, banks demand borrowers pay back their full mortgage arrearages once they’ve fallen behind.
For most families who find themselves struggling financially, this simply isn’t possible and they end up losing the home to foreclosure as a result.
By contrast, Chapter 13 debtors are able to dictate the terms of repayment to the mortgage company. Past-due amounts are broken up into small, manageable chunks and paid back over the life of the Chapter 13 plan. This allows the borrower to avoid foreclosure so long as they are able to maintain normal monthly mortgage payments from the date the case is filed.
Filing bankruptcy doesn’t give you a free house — you still need to pay the mortgage, but assuming you can, the automatic stay will prevent your lender from foreclosing.
Help with Mortgage Modification
This is another big benefit of Chapter 13. Not only can you dictate to your lender the terms under which you will pay back past-due mortgage payments, in some cases, you can force them to modify your mortgage.
While the Bankruptcy Code does not allow first mortgages on a debtor’s primary residence to be modified in bankruptcy, second and third mortgages can be modified through a process known as lien stripping. If you find yourself underwater on your home based on the balance of your first mortgage, additional mortgage liens are considered “undersecured” and are eligible to be removed or stripped by the bankruptcy court.
Once a mortgage has been stripped, the debtor pays the loan at pennies on the dollar with the rest of their unsecured debt.
Help with Car Payments
It is also important for consumers to know that the basic principal of lien stripping — modifying secured debt to meet the value of collateral — also applies to car loans. Chapter 13 debtors who find themselves underwater on a car loan have the option of “cramming down” the loan to match the value of the car. Note this option isn’t available if you’ve purchased your car in the last 910 days.
Help with IRS Problems
Perhaps a lesser known fact about Chapter 13 is that it can help with IRS problems.
According to bankruptcy lawyer, Rick West:
“Chapter 13 provides several benefits to borrowers dealing with IRS debts. Some taxes can be discharged as unsecured debts, much like a credit card or medical bill, at pennies on the dollar. Taxes that must be paid in full are paid more economically in a Chapter 13, since the IRS is not paid interest on the tax. Penalties are always paid as unsecured debts, even if the tax giving rise to the penalty must be paid as a priority claim. Finally, tax liens can be crammed down, and removed from property, often by paying much less than the amount of the lien depending on how much equity there is in the property.”
Disadvantages of Chapter 13 Bankruptcy
Of course, Chapter 13 bankruptcy has disadvantages as well, the most notable being the amount of time a case lasts. Chapter 13 plans last between 3-5 years. During that entire time, the debtor is obligated to commit all of their disposable income to the payment plan. Every penny after expenses must go toward paying back unsecured creditors. This is a big commitment that lasts quite awhile.
Many families don’t want their financial decisions restricted in this way, regardless of the relief that may be available.
Is Chapter 13 bankruptcy right for me?
Well, there you have it. Despite a sometimes-bad reputation, Chapter 13 bankruptcy can have advantages, especially if you are underwater on secured debts or facing foreclosure. However, some debtors will always be hesitant to enter Chapter 13 bankruptcy because it represents a big time commitment.
You may also be interested in:
- Why Chapter 13 Bankruptcy Has Your Second Mortgage Lender Feeling “Undersecured”
- Will a Chapter 13 Plan Look Better on My Credit Report Than Chapter 7?
- Converting from Chapter 7 to Chapter 13 Bankruptcy
Rob Cohen, the Managing Partner of Cohen & Cohen P.C., is a bankruptcy attorney that practices in Colorado and Wyoming. He serves as a Chapter 7 Bankruptcy Panel Trustee, and has to date administered over 8,000 Chapter 7 bankruptcy estates. Rob is a Certified Consumer Bankruptcy Specialist, and was nominated for Denver Business Journal’s 40 under 40 in both 2014 and 2016.