Chapter 7 and 13 Bankruptcy

Chapter 7 Bankruptcy

In a Chapter 7 bankruptcy case, a trustee is assigned to carefully examine both your financial circumstances and assets to determine if it is appropriate for you to be granted the extraordinary relief of having your debts completely forgiven. When a bankruptcy case is filed, a “bankruptcy estate” is created, consisting of things that you actually own and things you are treated as if you own. Some examples would be helpful here. A vehicle registered to you at the time of a bankruptcy filing clearly belongs to you and is part of the bankruptcy estate. An example of an asset that you would be treated as if you owned would be accident settlement proceeds not received until after your case filing, if the accident occurred before your bankruptcy case was filed. Assets that are part of the bankruptcy estate are subject to the control of the trustee. When he is permitted to do so by law, the trustee will liquidate any of these items to pay all, or some portion, of your debt to unsecured creditors. Whether or not the trustee will be able to liquidate anything that is part the bankruptcy estate is determined by the extent to which the item is protected under various federal and state laws. When an asset is protected under law it is referred to as “exempt” Receiving proper exemption guidance is absolutely critical since it literally determines what assets you are able to keep and which, if any, you will lose.

Most individuals are wise enough to seek proper exemption advice. Therefore, the overwhelming majority of Chapter 7 cases filed involve absolutely no repayment of debt or loss of personal property. (see question # 5 in the Answers To Bankruptcy Questions section for a broad discussion of exemptions) The opportunity to eliminate burdensome debt without losing any property is a very attractive prospect. Chapter 7 bankruptcy is so attractive, however, that in 2005 strong lobbying efforts by creditors resulted in significant changes to the bankruptcy laws designed to disqualify more people for Chapter 7 relief. One of these changes was the creation of a means test for bankruptcy qualification (see question #3 in the Answers To Bankruptcy Questions section for a full explanation of the means test)

While the creditors have not been as successful as they would have liked in denying Chapter 7 relief to individuals via the means test, this and other features of the new law, have made bankruptcy much more complex.

Chapter 13 Bankruptcy

Chapter 13 bankruptcy is designed to provide individuals with a structured, court supervised, means of repaying at least some portion of their debt through a series of 36-60 monthly payments. Many individuals will opt for Chapter 13 bankruptcy when they are disqualified for relief under Chapter 7 because of the means test or own assets that would be liquidated in Chapter 7. You may immediately recognize its similarity to credit counseling (or debt management). There are, however, three critically important distinctions. First, participants in a credit counseling program may be subject to collection phone calls and even legal action if the creditors grow impatient in waiting for payment. The automatic stay which takes affect when a bankruptcy is filed, strictly prohibits any collection activity, so neither collection calls nor the filing of a lawsuit is possible Second, in attempting credit counseling with a given creditor you are at the mercy of what the creditor believes that you can reasonably pay. In contrast, Chapter 13 bankruptcy establishes objective standards for determining your ability to pay. You are permitted to deduct from your gross income the actual amount of your monthly expenses in several categories such as mortgage and vehicle payments. Additionally, you are permitted to take deductions in an amount considered reasonable according to IRS standards for expenses such as the cost of operating a vehicle and non mortgage or rent related household expenses. (note that the IRS standards are fairly liberal and frequently exceed the amount actually spent in those categories) Third, payments made in credit counseling always include interest. In most cases, the payments made in a Chapter 13 bankruptcy case do not include interest. Because only principal is usually repaid, Chapter 13 bankruptcy can result in significant savings even when available disposable income requires 100% repayment of debt.

As previously mentioned, Chapter 13 bankruptcy is often filed because an individual is disqualified for Chapter 7 under the means test or has non-exempt assets that would be liquidated in Chapter 7. However, there are instances in which Chapter 13 is the better option whether or not you are eligible for Chapter 7. *Three of the more common reasons for filing Chapter 13 Bankruptcy whether or not you are eligible for Chapter 7 are (1) delinquency on a mortgage (2) desire to remove a wholly unsecured second mortgage from your homestead (3) desire to restructure a secured loan on a vehicle to repay it’s fair market value at a reduced interest rate (*this is a partial list, there are others as well)

Mortgage Delinquency

When you become delinquent on a mortgage due to a temporary life event, you could eventually catch up if only the creditor would work with you. Unfortunately, lenders often will refuse to work with you when you are delinquent and insist that the full outstanding amount be paid. Chapter 13 essentially forces the lender to cooperate. Chapter 13 Bankruptcy enables you to resume making the normal mortgage payment and satisfy the delinquency over the course of your 36-60 month Chapter 13 Plan. Stretching the delinquent payments out over a lengthy period will often make the payments manageable. As an example, if your normal mortgage payment is $800.00 per month and you are six (6) months delinquent, a Chapter 13 Bankruptcy would allow you to resume the $800.00 payments within 30 days and pay approximately an additional ($133.33) toward the delinquency assuming a 36 month plan or approximately ($80) toward the delinquency assuming a 60 month plan. In some cases, even the normal mortgage payment is beyond your ability to pay and/or the delinquency has grown so large that it can not reasonably be paid within 36-60 months. Under these circumstances, a loan modification should be considered in the Chapter 13 case in order to reduce the monthly payment to a comfortable level and make arrangements to restructure the delinquent portion of the mortgage with new terms.

Removal Of Second Mortgage

During the rapid increase in real estate values that occurred a few years ago, many homeowners were aggressively solicited to originate second mortgages to access their home’s equity. A significant number of those who originated second mortgages now find themselves “underwater”, in many cases, with a home valued at even less than the remaining balance on their first mortgage. Chapter 13 Bankruptcy can be a particularly powerful tool for an individual in this position. If your home’s value is so low that not even one dollar of its value provides security for your second mortgage, it can be removed (referred to as “stripped”) with a Chapter 13 Bankruptcy. For instance, if your home has a current value of $100,000, subject to a first mortgage of $125,000 and a second mortgage of $25,000. you would be able of strip off the second mortgage entirely.

Reducing Vehicle Debt To FMV

A vehicle purchased more than 910 days before the date of a bankruptcy filing and used personally may have its lien reduced to the vehicles fair market value. The vehicles fair market value is classified as the secured portion of the loan and any remaining amount owed is classified as the unsecured portion. The secured portion will be paid over the course of the Chapter 13 Plan (36-60 months) at an interest rate ranging between 1-2 % above the prime rate, which, at the present time, would result in a new interest rate of about 5%. The unsecured portion will receive the percentage being paid to other unsecured creditors under the Plan. For instance, assume that you purchased a vehicle in 2009 which has a current balance owed of $12,500 at 10% interest with a fair market value of $7,000 and your Chapter 13 Plan proposes to pay 10% to unsecured creditors with a plan length of 60 months. The result in Chapter 13 Bankruptcy would be as follows: The debt would be reduced to $7,000 paid at 5% and the remaining $5.500.00 would be repaid at 10% ($550.00) Both the secured and unsecured portion of the loan would be paid during the 60 month Chapter 13 Plan period. The difference between these two figures, $4950.00 ($5,500.00 – $550.00) would simply be eliminated.