Gone are the days when the word ‘bankrupt’ conjured the image of a destitute man, begging for food, bottle of whisky in hand, having lost his fortune and family to scandalous business dealings.
In fact, quite the opposite is true today. We are seeing another extreme, with some business owners abusing bankruptcy to discharge unwanted debts and clean the proverbial slate, over and over again. While an experienced, credible attorney would never advise such a strategy (in some cases, excessive bankruptcy filing can even be illegal), it does illustrate how bankruptcy has evolved in recent decades.
Unsecured vs Secured Debt
In total, there are five chapters of bankruptcy available to individuals and businesses. Your personal/business goals and objectives, along with your current financial situation, will determine which type is right for you. Of the five chapters, most qualifying individuals file Chapter 7 because it basically forgives all dischargeable debts, including credit card debt, unpaid medical and utility bills, and back rent. These debts are unsecured, meaning they are not tied to any form of collateral.
Secured debt, such as back mortgage payments and outstanding payments on vehicle loans, are not dischargeable in Chapter 7 bankruptcy. Individuals who have significant secured debt aren’t likely to benefit from filing Chapter 7 as it will not forgive outstanding loan payments on their home, car, or other loans tied to collateral. If they wish to keep their home and vehicle(s), Chapter 13 bankruptcy is almost always the better option.
Discharge vs Reorganization
Chapter 13 focuses on reorganizing debts into a repayment plan, rather than eliminating them. Although it might seem counterintuitive to enter a repayment plan instead of just having all debts discharged forever, some debtors simply don’t have a choice. If your income is relatively high or you have significant secured debts you want to hang onto, Chapter 13 might be your only viable option.
The Means Test
The Means Test is used to determine whether you have enough disposable income to successfully complete a Chapter 13 repayment plan. Creditors have an obvious preference for Chapter 13 as they will receive at least some payment on what is owed to them, whereas they won’t receive a dime if you file Chapter 7.
If your disposable income is above a certain level, you will fail the Means Test and will be required to file Chapter 13. But failing the Means Test isn’t the only reason people file Chapter 13. The ability to keep secured debt and reorganize debts that are not dischargeable is another.
How Chapter 13 Reorganization Works
Let’s say you’ve fallen behind on car, mortgage, and student loan payments to the tune of $45k. Your home is about to go into foreclosure, your car will soon be repossessed, and your student loans are in default. In a Chapter 13 bankruptcy, the past due payments will all be rolled into a single, three-to-five year repayment plan—approved by your creditors—effectively making you current on your loans.
Through the Chapter 13 repayment plan, you will make a monthly payment to the bankruptcy trustee in the agreed-upon amount for the agreed-upon period (between three and five years). The trustee will in turn distribute the designated amounts to your creditors for the allotted time period. In addition to mortgage and vehicle loan arrears, debtors can include past-due taxes, child support payments, and even some legal fees in the repayment plan. Any outstanding unsecured debts, such as medical bills and credit cards, can be rolled into the plan as well.
How are Payments Calculated?
To determine the amount that each creditor will receive through the repayment plan, the Chapter 13 trustee will review the amount of debt owed, the types of debt owed, and your income to expense ratio. At the end of this three-to-five year repayment plan, any remaining balances will be discharged, meaning you will be relieved from any further financial obligation. This is true even if you didn’t pay off the entire outstanding balance during the repayment period.
Additional Benefits of Chapter 13
Chapter 13 is also an attractive option because it gives the debtor the duration of their payment plan to pay off past due loans and hang onto secured property, while keeping creditor calls and collection actions at bay. There are also some creative ways to use Chapter 13 bankruptcy in conjunction with Chapter 7 bankruptcy in a process often referred to as Chapter 20. People who have too much unsecured debt to qualify for Chapter 13 may first choose to file Chapter 7, discharging credit cards, utility bills, and personal loans. Immediately following the Chapter 7 discharge, they may then file Chapter 13, reorganizing mortgage arrears, past-due taxes, and outstanding vehicle loan payments into a repayment plan.
Chapter 13 also allows debtors to roll domestic support obligations into a repayment plan, reduce the amount owed on older vehicle loans (known as a cram down), and more effectively manage student loan payments. Furthermore, Chapter 13 can protect co-signers from having to pay on certain loans.
Bankruptcy isn’t for everyone, but sometimes it’s exactly what an individual or business needs to get a fresh start. If you are considering bankruptcy, it’s in your best interest to consult with an experienced attorney today like the team at Legal Solutions of New Mexico.