Chapter 13 Bankruptcy

What Is Chapter 13?

Chapter 13 refers to a U.S. bankruptcy proceeding in which debtors undertake a reorganization of their finances under the supervision and approval of the courts. Individuals and married couples, even if self-employed or operating an unincorporated business, are eligible to file for Chapter 13 bankruptcy.

As part of a Chapter 13 reorganization, which is also known as a wage earner's plan, debtors must submit and follow through with a plan to repay outstanding creditors within three to five years.

In most circumstances the repayment plan must provide a substantial payback to creditors — at least equal to what they would receive under other forms of bankruptcy — and it must, if needed, use 100% of the debtor's disposable income for repayment.

Understanding Chapter 13

With a Chapter 13 bankruptcy, debtors must compile a list of all creditors along with the amount of money owed to each, a list of any property owned, information about income amounts and sources, and detailed information about monthly expenses.

A debtor then pays an agreed-upon monthly amount to an appointed, impartial bankruptcy trustee, effectively consolidating debts into one monthly amount. The trustee in turn distributes the money to the debtor's creditors. Debtors have no direct contact with creditors under Chapter 13 protection.

People are eligible to use Chapter 13 only if their debts are below certain limits: $419,275 for unsecured debt and $1,257,850 for secured debt as of February 2019 (increases come in three-year intervals). Filers must also have completed credit counseling to be considered eligible for Chapter 13.

Chapter 13 vs. Chapter 7

Chapter 7 is the most common form of bankruptcy, as it allows individuals to erase their existing debt and start afresh. Unfortunately, Chapter 7 filers are often required to surrender their home. Once a Chapter 13 bankruptcy is initiated, any home foreclosure proceedings are ceased.

A debtor may be motivated to choose Chapter 13 over Chapter 7 in order to save their home.

Chapter 13 vs. Chapter 11

Chapter 11 bankruptcy is another plan in which debt is restructured and paid back over time. Although it is available to individuals, couples, and businesses, it's filed most frequently by businesses because it is expensive and complicated.

Chapter 13 gives filers who make too much money to be considered for Chapter 7 an easier alternative to Chapter 11. Filing for Chapter 13 bankruptcy may also protect cosigners of the debtor's loans from being held responsible for them.

Chapter 13 and the CARES Act

The Coronavirus Aid, Relief, and Economic Security (CARES) Act, signed into law by the president on March 27, 2020, made a number of changes to bankruptcy laws designed to make the process more available to businesses and individuals economically disadvantaged by the COVID-19 pandemic.

For Chapter 13, these include excluding federal emergency relief payments due to COVID-19 from "current monthly income" and "disposable income" and allowing repayment plans to be extended to seven years. The changes apply to bankruptcies filed after the CARES Act was enacted and sunset one year later.

Example of Chapter 13 Bankruptcy

After Eric lost his job, and his husband, Joey, suffered a medical crisis that left him unable to work, they fell behind on their mortgage and were $25,000 in arrears. The bank had initiated foreclosure proceedings just as Eric received a job offer and Joey launched a small business.

By filing for Chapter 13 bankruptcy, they were able to stop the foreclosure and keep their home. With their now-steady income, they are able to pay their mortgage each month while also spreading the $25,000 back payment over a five-year period.