Most people prefer to file for Chapter 7 bankruptcy because it quickly wipes out qualifying debt without requiring you to pay back creditors. However, if you’re behind on your mortgage or vehicle payment and you want to keep the home or car, Chapter 7 bankruptcy won’t help you. Instead, you’ll need to pay into a three- to five-year Chapter 13 bankruptcy plan. However, the good news is that if you qualify for Chapter 7 bankruptcy, your monthly Chapter 13 payment might be more affordable than you expect.
Sometimes, however, a debtor who qualifies for Chapter 7 bankruptcy might be better served by filing a Chapter 13 matter. For instance, a Chapter 7 bankruptcy won’t help a debtor who is behind on a mortgage or vehicle payment (called secured debt) keep the property. A debtor must pay secured debt according to the contract terms; otherwise, the lender will foreclose on the house or repossess the car.
That’s when Chapter 13 bankruptcy is a better bet. It gives a debtor three to five years to catch up on arrearages so the debtor can save the home or keep the car.
A Chapter 13 zero percent plan is a repayment plan that doesn’t pay any money to nonpriority unsecured debts, like credit card bills, personal loans, and medical balances. Most Chapter 13 filers with high incomes have disposable income that can (and must) be used to pay such creditors.
The Chapter 7 means test—the test that determines whether someone is qualified to receive a Chapter 7 discharge (the order that wipes out debt)—examines the availability of disposable income to pay creditors. In other words, an individual with disposable income that can be used to pay something toward nonpriority unsecured creditors in a Chapter 13 bankruptcy will fail the Chapter 7 means test (more below).
By contrast, a debtor who passes the means test won’t have disposable income to pay nonpriority unsecured debt. And the calculation won’t change just because a debtor files a Chapter 13 case. Therefore, such a debtor will likely be able to save money by proposing a zero percent plan in courts that allow them.
A zero percent plan doesn’t mean that a debtor pays nothing at all. You’ll have to pay your monthly house and car payment, plus any arrearages over the course of a three- to five-year repayment plan. You’ll also have to fully repay any priority debt that you might have, such as domestic support arrearages and most tax debt.
However, you won’t have to pay anything to your nonpriority unsecured creditors. And, if that debt is dischargeable in a Chapter 13 case—such as credit card balances, medical and utility bills, and personal loans—it will get wiped out when you complete your plan payments.
In other words, all you’ll pay are those things that you’d be left responsible for if you filed a Chapter 7 case. Also, you’ll keep your property, and won’t pay anything on debt that would typically get wiped out in a Chapter 7 case.
Chapter 7 bankruptcy discharge eligibility requires you to establish one of two things:
Expenses that are deductible from your income include:
You’re allowed to use your actual expense for some items. For others, you’ll use predetermined amounts. If the calculations show that you have disposable income left over after taking the deductions, you must file a Chapter 13 case. Otherwise, a Chapter 7 matter is available to you.
(To learn more about qualifying for Chapter 7 bankruptcy, go to The Bankruptcy Means Test.)
In most cases, the means test calculation won’t change if a Chapter 7 qualified debtor decides to file for Chapter 13 bankruptcy to catch up on a secured debt. In the zero percent plan, the debtor will likely propose to pay the following over three to five years:
The debtor must pay any priority debt in full over the course of the plan. However, the balance owed for all arrearages, car payments, and priority debts can be spread out over the duration of the plan.
Also, being a zero percent plan, the debtor won’t have to pay anything to nonpriority unsecured creditors. Balances on any of those debts will get wiped out after the debtor completes the plan. (You’ll find an example demonstrating how this works in What Is a Bankruptcy Zero Percent Plan?)
As with any Chapter 13 case, the debtor will have to demonstrate that the debtor has sufficient monthly income to make the plan payments.
(For more information, go to Chapter 13 Bankruptcy.)
In bankruptcy, you’re allowed to protect (exempt) a certain amount of equity in a house or car. You can find out how much by checking your state exemption laws.
In a Chapter 7 bankruptcy, the bankruptcy trustee appointed to your case will sell the property and distribute the nonexempt equity amount to creditors. In a Chapter 13 bankruptcy, you can keep your property, but you’ll have to pay creditors for the nonexempt equity through your plan.
Significant amounts of nonexempt equity will drastically increase a plan payment, and many debtors won’t have enough income to make the high payment. In such a case, filing for bankruptcy might not be your best option.
Preparing a Chapter 13 bankruptcy is complicated, and most people need help from a bankruptcy attorney. Also, not all jurisdictions allow for zero percent plans. A local bankruptcy lawyer will be in the best position to explain your options.