Many consumers view bankruptcy as a bad word that often befalls people who are irresponsible with their money. But the truth is that bankruptcy is a legal strategy and procedure provided by the federal government for people who have found themselves with insurmountable debt.
There are different types of bankruptcy, but the two most often used by individuals are Chapter 7 and Chapter 13. While the two are similar, there are major differences.
We’ve told you about Chapter 7, how it works and who should file, but now we’re going to explore Chapter 13. While Chapter 7 is especially useful for people who are no longer working, Chapter 13 has the distinction of being known as the “Wage Earner’s Plan.”
Chapter 13 bankruptcy: How it works
When someone files for Chapter 13 bankruptcy, their troubles stem from not necessarily lacking the money to pay their debts, but from not being able to produce immediate payments. That’s why in many ways Chapter 13 is more of a debt reorganization plan.
“Of course, there has to be some money left in your budget of future projected income and expenses to fund your plan,” Detroit, Michigan-based bankruptcy lawyer Kurt O’Keefe tells Team Clark.
“Your plan payment is the difference between your projected income and expenses. That also must be enough to pay your creditors at least what they would get in a Chapter 7,” he says.
Most Chapter 13 repayment plans will last three to five years, depending on just how much debt the person has accumulated. A trustee will be appointed to disperse the funds to creditors.
Who should file for Chapter 13 bankruptcy?
You don’t necessarily have to be overwhelmed by debt to file for Chapter 13, O’Keefe says. There could be a situation where you find yourself in a financial pickle and need a little help, like if your credit card bills become too difficult to pay.
“Or, you fell behind in your house payment, and need time to catch up,” he says. “Chapter 13 prevents the mortgage company from foreclosing while you do that.”
To determine whether you’re a prime candidate for Chapter 13 bankruptcy, it’s necessary to look at not only how much money you have in your accounts, but the various assets you possess, as well. Do you own property out of town somewhere? Is your name attached to a boat in the marina? Everything you have paperwork for may come into play.
Your reorganization plan will typically involve your exempt assets (property you get to keep, like a home, car on other personal belongings) and non-exempt assets (possessions that could be sold to pay your creditors).
“Candidates for Chapter 13 are people who have non-exempt assets they want to keep, as the Chapter 13 trustee does not sell non-exempt property, but handles your plan payments and disburses to creditors according to your confirmed plan,” O’Keefe says.
What effect will Chapter 13 bankruptcy have on your credit?
A consumer who files for Chapter 13 bankruptcy may see their credit score plunge as much as 200 points. If you have a credit score of around 700, it is not uncommon to see it drop to 500, according to the major credit-reporting bureaus Equifax, TransUnion and Experian.
From the date that the bankruptcy is filed, a consumer can expect Chapter 13 to remain on their credit for several years, according to TransUnion’s website. “The actual accounts included in bankruptcy remain on file for up to seven years from the date of closing/last activity regardless of the chapter pursuant to which you filed,” it says.
So, the sooner you pay off your creditors, the quicker your credit can be restored.
How to emerge from Chapter 13 bankruptcy?
Contrary to popular belief, a completed or dismissed Chapter 13 won’t follow you around forever. “Getting good credit again is based on, as always, paying bills on time,” O’Keefe says.
Consumers can emerge from Chapter 13 early in many cases, finishing their typical three-to-five year plan before that by paying down their debts. Over the course of the plan, it’s customary to see your credit score rise gradually.
Money expert Clark Howard says that he sees people make a big mistake when opting for bankruptcy.
“Often I find that people file for bankruptcy when they’ve had one too many calls from the debt collector,” Clark says. “But that’s not the reason to file.” Here’s the reason a person should declare bankruptcy, according to Clark.