Very often I will sit down with a new consult and one of the first things they say is “I want this to be a Chapter 7, I don’t want Chapter 13.” I always then ask “Why do you say that?” because the answer gives me insight into what they have already learned (either through reading or talking to someone else, which is often wrong) and what kind of result they are looking for. Very often these same folks end up being excited about the idea of going through a Chapter 13. Here’s why:
Chapter 13 is a wonderful tool that creates results in certain circumstances that we cannot make happen in Chapter 7 such as:
- Catching up mortgage arrearages over time and avoiding foreclosure;
- Stripping second and third mortgages from a primary residence;
- Managing non-dischargeable IRS or other debt that we cannot get rid of in Chapter 7 (like alimony/child support arrearages or some fraud judgments); and
- Cramming down secured debt on some vehicles (along with the interest rate on the debt).
If a debtor has consistent income, but it doesn’t seem to be enough to go everywhere they need it to, then Chapter 13 may very well be the answer. This is how it works:
In Chapter 13, the debtor creates a plan that will be followed for three to five years. As long as the plan is maintained, the debtor is under the protection of the Bankruptcy Court. This means that no creditor may call, mail, garnish, sue or do anything that would constitute a collection, besides file a claim for payment with the Court.
The plan payment is customized to the debtor’s particular circumstances, including income, living expenses, secured debt, priority debt, attorney’s and trustee’s fees and unsecured debt. We first look at income compared to living expenses (the Trustee calls this “Feasibility”). We do this because a plan is not going to be successful if the debtor can’t afford to pay living expenses and meet the requirements of the plan.
Make a list of the monthly take home pay and a list of regular monthly living expenses (no debt payments) and then compare the two. Is there money left over after living expenses that could be used to make a Chapter 13 Plan payment? If the answer is “No”, then it’s not going to work and filing a Chapter 13 would be a waste of everyone’s time and effort. If the answer is “Yes,” then we go to the next step:
What is the minimum floor for a plan? We have to look at several elements that go into calculating a plan:
- Secured Debt;
- Priority Debt;
- Unsecured Debt; and
- Administrative Fees.
Secured Debt: Jurisdictions differ, but in the Middle District of Florida all secured debt is required to be maintained through the plan. This means that mortgages and car payments (these are the most common kinds of secured debt) will be included in the plan payment and those creditors will be paid by the Chapter 13 Trustee. Any mortgage that is being kept and treated as secured debt (remember we are often reclassifying second mortgages and Home Equity Lines of Credit as unsecured debt right now) will be padded with two extra payments (we call them GAP payments) so the mortgage company can’t bombard debtors with surprise unpaid fees at the end of a plan.
I know it shocks you to hear that banks do that, but they do. The secured portion of car loans can be “crammed down” to the NADA retail value of the vehicle if the loan is more than 2 ½ years old. The balance is treated as unsecured debt. The interest rates on vehicles paid through the plan can be changed to a fixed rate (on the day I write this it is 5.25%) for the life of the plan.
Priority Debt: Priority Debt is debt that cannot be discharged in a Chapter 7 or Chapter 13 Bankruptcy, but can be structured to be paid in full across a Chapter 13 Plan. Priority Debt can be (but is not limited to) Back Child Support or Alimony, and/or Taxes owed to the IRS for recent tax years or wages owed to employees.
Priority debt must be paid in full across the plan term. So if a debtor owes $5,000 in Priority Debt and goes into a 60 month (5 years) plan, $83.33 of each monthly plan payment would go toward satisfying that debt.
Unsecured Debt: Unsecured debt is anything that is not Secured or Priority debt. This category includes credit cards, medical bills, deficiencies from debt that used to be secured (like a car repo balance, property foreclosure). Student Loans, even though unpaid amounts survive any bankruptcy, are classified as unsecured debt (pure evil, if you ask me).
Figuring the treatment of unsecured debt in a Chapter 13 Plan is involved and tricky. The attorney has to figure out how much, if any, money would have been paid to the unsecured creditors if the case had been filed as a Chapter 7. This is called “liquidity.” The equivalent of liquidity must be paid to the unsecured creditors across the life of the Chapter 13 plan. That is a minimum.
If there is money available in the debtor’s budget (remember take home pay vs. living expenses?) to pay above liquidity to unsecureds, then that amount will be required. It is the attorney’s job to make sure that no more than necessary is paid by the debtor/their client into the Plan to unsecured creditors.
Administrative Fees: These vary among the jurisdictions. In Orlando where I am, some attorney’s fees can be paid through the plan and the Chapter 13 Trustee charges 10% to keep things going on his or her end.
You’re still waiting for the part where you get excited about the idea of being in a Chapter 13? Here it is:
Our typical Chapter 13 client right now starts out owing more on their home than it is worth with multiple loans, has IRS debt from a business that has failed, has personal guarantees on debt from the business that has failed, and owes as much or more than what their car is worth with an interest rate on the loan of 8% or higher.
They have a good income, it’s just not enough to maintain everything. In Chapter 13, the plan would:
- Keep the first mortgage current and strip the others from the home (so the home would only have the first mortgage and would be current at the end of the plan);
- Pay off the IRS over five years, discharge the personal guarantees on the business debt;
- Pay off the car at its present value or loan balance (whichever is lower) at 5.25% over the 5 years; and
- Likely pay something to everyone else, but only after living expenses, secured debt and priority debt have been addressed.
At the end of five years the client is DEBT-FREE except for the first mortgage, which is current. Now be honest, can you get there on your own in five years? Is there any way? If the answer is “No,” then you owe it to yourself and the ones who depend on you to explore the option of Chapter 13.