I’ve lost count of the number of times I have recommended a Chapter 13 Bankruptcy to a client only to have them stare back at me with their eyes bulging, and usually with one of the following responses:
“Isn’t that the one where I have to pay everything back?”
“Why should I bother filing for bankruptcy if I have to pay everything back?”
Or some combination of all three.
One of the major problems with getting legal advice from your friends at the bar is that an entire new field of “faux law” develops. Assumptions are made, facts are distorted, and words are used carelessly. Before you know it, a new bankruptcy myth emerges that bears little or no resemblance to reality.
I spoke about this once before. The notion of “filing against debts” gave rise to a mistaken notion shared by many of my clients that whether a debt would be discharged or not had to do with whether or not it was listed on their bankruptcy schedules. I’m not going to go down that road again. Suffice to say, listing creditors on bankruptcy schedules is a due process requirement, and has very little to do with the discharge. You can read more about that here.
Filing Chapter 13 Bankruptcy does not [necessarily] mean you are paying everything back. So, how does this myth get started?
Well, for one thing, if you are in Chapter 13 – you are indeed making monthly payments to the Trustee. The way I explain it to my clients (at the beginning of our consultations, before I have specific facts of their case) is that… Chapter 13 is a 3 to 5 year debt consolidation and repayment program. We take all of your debts, pool them together, and break them up into categories. Then, based on the types of debts you have and the circumstances of your case – certain debts will be paid in full and other debts will be paid a percentage – based primarily on income but sometimes other factors.
Let’s take a simple example… Unmarried individual makes $20k per year, he has a car loan and three credit cards. He qualifies for Chapter 7 based on in his income, but he has a prior bankruptcy case that makes him ineligible to refile a Chapter 7 at this time. In his case, he will make monthly payments to the trustee – he will pay off the secured balance on his car during the life of the plan, and he will likely pay nothing to his unsecured creditors based on his income. In this particular example, he may very well be paying the exact same thing he would have been paying if he filed Chapter 7, except instead of paying his auto creditor directly, he pays the trustee. And, with up to 60 months to do the Chapter 13, and the possibility of lower interest rates and a possible reduction of the principal balance – he is actually paying LESS in Chapter 13 than he would have been paying if he filed Chapter 7. So, while it is true he is making monthly payments, he is certainly not paying “everything” back, and in this case, he’s actually better off than he was in Chapter 7.
Does everyone come out of Chapter 13 faring so well? No. Often, people in Chapter 13 will pay back something to their unsecured creditors, but seldom do they pay it all back. People file Chapter 13 either because they make too much money (in which case they’re paying unsecured creditors a percentage based on income) or they’re filing Chapter 13 for a non-income reason, and most of those reasons require a percentage to unsecured creditors.
And of course, many priority (taxes, domestic support, etc.) and secured debts (auto loans, mortgage arrears, etc.) do have to be paid in full. Though, not always, so don’t let the general rule frighten you. Talk to a bankruptcy attorney to find out exactly what does and what doesn’t have to be paid if you choose to file Chapter 13 Bankruptcy.
Are there cases where debtors have to pay back all of their debts? Yes, there are. These are relatively rare, but there are several different ways this could happen. Someone could make so much money relative to their debt (remember that bankruptcy is less concerned about income and more concerned with your debt-to-income ratio) that the formula set forth by Congress determines that you have to pay back all of your debt. Or, if you’re filing for a non-income reason, that reason may also force you to “pay it all back” – though these scenarios are far less common.
So, let’s say you’re that rare debtor – the one unfortunate enough to find out from your attorney that you have to file Chapter 13 and “pay it all back”. Why bother filing?
Well, maybe you don’t want to file. But don’t rule it out just yet.
For starters, you’re still probably not paying it all back. Interest rates on debts in Chapter 13 vary by district, but they are almost always better than what you would be paying contractually. For example, in the Eastern District of Wisconsin, priority debts and general unsecured debts are all paid with 0% interest. Mortgage and lease arrears are also paid at 0% interest. The only real interest that gets charged are for other secured loans (such as vehicle loans), and those receive “Till interest” which is prime rate plus 1-3%. Prime rate has been stuck at 3.25% for several years now, so unless you have ridiculously low rates on your vehicles and interest free credit cards, you’re still getting relief on interest rates.
You will still benefit from the automatic stay – which means any adverse collection actions (ranging from wage garnishments and bank levies to repossessions and foreclosures – and including annoying creditor phone calls) all stop. Apart from any long-term debts, you can walk out of Chapter 13 debt free, with a reorganization plan that will put you in much more control than you are perhaps feeling right now.
The lesson of today’s story is that you shouldn’t get your legal advice from a bar stool. What happened in your friend’s bankruptcy case is unlikely to be what happened in your bankruptcy case (for better or for worse). Results vary by the circumstances of each case. Get the facts from an experienced bankruptcy attorney.