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Chapter 13 is often called a “wage earner’s” bankruptcy or “payment plan” bankruptcy. If a person is employed and making more than the median income or has disposable income (but not enough to meet their current debt obligations), a Chapter 13 filing could help them by reducing all monthly debt payments to a single affordable monthly payment.
Chapter 13 bankruptcies offer additional benefits as well. For instance, loans on secured property such as cars or homes can often be “crammed down” to the present fair market value of the asset. Therefore, if you are upside down on you car loan, a Chapter 13 filing can often bring you right side up. Similarly, in a Chapter 13 many people are able to completely strip second mortgages or HELOCs from their primary residences. This powerful ability makes a Chapter 13 filing the ultimate loan modification tool.
Qualifying for Chapter 13
In order to file a Chapter 13 an individual must have regular income with sufficient disposable monthly income to make a regular plan payment. Disposable income is determined by taking a Debtor’s gross monthly income and subtracting allowable living expenses. A Debtor cannot be in the negative each month going into a Chapter 13 or their plan of reorganization will eventually fail.
In addition, a person filing Chapter 13 cannot have more than $360,475.00 in unsecured debt or $1,081,400.00 in secured debt. Unsecured debt consists of debts such as credit cards, personal loans, student loans, tax liabilities and also includes the undersecured portion of secured debts.
Chapter 13 Plan Requirements
In order for a Chapter 13 plan to be confirmed it must meet several distinct requirements. The first requirement is duration.
- Duration: A Chapter 13 plan can be between 36 and 60 months. Debtors whose income as measured at the time of filing is below the median income for their household size can propose a 36 month plan. Debtors whose income is above the median income for their household size must propose a 60 month plan (but no longer). For debtors who are self employed, their gross receipts determine whether they are below or above the median income without consideration of the expenses associated with running their businesses.
- Disposable Income: In addition to meeting the duration requirement, a Chapter 13 plan must commit the debtor’s entire disposable monthly income towards repayment of the debts. Thus, if after all legitimate monthly living expenses are paid an individual has $500 left each month, their plan payment must commit this amount towards repayment of their debts.
- Best Interest of the Creditors: A somewhat difficult to explain requirement of a Chapter 13 plan is the requirement that the plan be in the best interest of the creditors. In reality this comes down to a strict liquidation analysis. Thus, the debtor must disclose all of their assets and these assets must be valued with a fair market value. A liquidation value is therefore assigned to these assets and the Chapter 13 plan must pay the unsecured creditors at least as much as this liquidation value. The logic behind this test is to ascertain whether creditors are better served by a Chapter 13 plan or whether a Chapter 7 liquidation of the debtor’s non-exempt assets would pay the creditors more. Naturally, if a debtor has substantial non-exempt assets, this test might not be met by commitment of the disposable income alone for the minimum required duration. Hence, some debtors are required to propose plans longer than 36 months even when they qualify for a 36 month plan based on their income.
An undersecured debt is one where the value of the collateral securing the debt is less than the outstanding obligation. For example, many people have an undersecured portion of debt on their vehicles because the value of their vehicle has fallen below the value of their loan due to the natural depreciation of their vehicle. Chapter 13 allows debtors the ability to cram down certain undersecured debts so that they only pay back the fair market value of the collateral. Debtors who are upside down on their vehicle loans and loans on real estate (other than their primary residences) can cram down the associated debts if these debts were incurred prior to 2.5 years before they file their bankruptcy case.
Stripping of HELOCs and Second Mortgages
When a secondary lien on a primary residence is undersecured because the value of the debtor’s home has fallen below the outstanding value of the first mortgage, then it is possible to completely strip the second mortgage or HELOC in a Chapter 13. To do so usually requires the filing of a motion or an adversary proceeding requesting that the Court order the lien null and void when the Chapter 13 plan is completed. Valuation issues sometimes arise in these cases. Therefore, we always utilize professional appraisers to assess our client’s home values when we intend to strip a second mortgage.
Saving Your Home With Chapter 13
Chapter 13 offers one significant benefit over Chapter 7 for those homeowners who are behind on their mortgages and wish to save their homes from foreclosure. If an individual is behind on their mortgage payments and files a Chapter 13 they may propose a Chapter 13 plan that pays back the arrearages on their mortgage over the course of 36-60 months at 0% interest. If in such a situation, the homeowner makes every regularly scheduled mortgage payment that comes due after the filing of the Chapter 13 case and makes all plan payments, then their lender must accept this result and cannot foreclose on the home.
Self-employed Debtors must also file monthly business operating reports and their disposable income will be based on the net operating income of their business regardless of how much they actually draw. Self-employed Debtors must also base their plan length on the gross income of their business.