What Happens When You File Chapter 13 Bankruptcy?
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Benefits of Chapter 13
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Most people probably think going bankrupt means losing everything, selling all your assets and starting over from scratch. In reality, bankruptcy is designed to help debtors, and even in a bankruptcy liquidation, they're able to retain some of their assets, as they have a lot of their debt forgiven. Because of a change in the laws in 2005, most individuals or married couples filing for bankruptcy are forced into Chapter 13. This doesn't give much in the way of debt forgiveness, but it does have its advantages. For one, Chapter 13 can prevent a home foreclosure and help a delinquent homeowner get current on their mortgage. Under Chapter 13, debtors undergo a sort of debt consolidation, making regular monthly payments to a court appointed trustee who then distributes the funds to creditors according to a predetermined restructuring plan. Forming the restructuring is the primary task of Chapter 13 bankruptcy.
Debt Restructuring
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With any bankruptcy filing, a debtor must begin with a complete and thorough statement of their assets, income, debts and other obligations. But, whereas in Chapter 7, a debtor would be forced to liquidate their nonexempt property, most assets are kept (or at least can be) under Chapter 13. The major issues are secured debts (meaning those collateralized by property in the debtor's possession) and delinquent debts (meaning those with payments overdue). With the help of the court appointed trustee, the debtor meets with creditors and decides how they can best repay their debts. Those that are delinquent can be renegotiated down to a lower interest rate, have late fees forgiven, or can be financed over a longer period with lower monthly payments. With collateralized debts, the options depend on the relationship between the current market value of the collateral versus the outstanding principal of the debt. If the debt is greater than the collateral, the debtor can either pay the debt in cash or return the collateral as full satisfaction of the debt. If the collateral has more value than the debt, they must either pay the debt or risk losing the property, which will be liquidated. When making these determinations, the trustee ensures that the all of the debtor's disposable income for at least three years is committed to the debt repayment plan, up to the extent of the debts, and that creditors receive at least as much as they would under a Chapter 7 bankruptcy.
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Life After Bankruptcy
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A filing for Chapter 13 bankruptcy will remain on an individual's credit report for seven years, but so will debt that's been charged off by a creditor. The damage to one's credit is often the biggest concern of those considering bankruptcy, but in reality, an individual's credit starts to improve from the moment their bankruptcy is discharged. Loans and mortgages will be more difficult to get, and more costly, for a few years -- in fact, their interest rate on loans will probably be at least 2 to 3 points higher than those with a similar credit score but no bankruptcy, and their rate on credit cards can be 15 to 25 percent greater. Still, if they stay good standing, these rates can be negotiated down. After one year of maintaining good credit, they'll be eligible for an FHA-secured home loan, and for an unsecured credit card after 18 months. Over time, as long as they satisfy the terms of the Chapter 13 restructuring plan and pay their bills on time, an individual gradually regains all the rights and responsibilities they had before bankruptcy.
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- Photo Credit Dave Johnston
