The Chapter 13 Bankruptcy Trap

Key Takeaways
  • Chapter 13 and Debtsettlement, both save money by paying creditors less than the full amount owed.
  • The bankruptcy trustee oversees your repayment plan, which requires you to contribute 100% of your disposable income to creditorsfor five years.
  • An improvement in your financial circumstances means more money for creditors while in bankruptcy.

Chapter 13 bankruptcy requires you to repay creditors for five years before receiving a discharge of qualified debts. After taking a pre-bankruptcy course through a HUD-approved credit counseling agency, you can file for bankruptcy protection.

The filing immediately shields assets with a temporary stay by stopping any court proceedings, such as foreclosure or wage garnishments, giving you time to catch up on accounts secured by the assets you want to keep.

In the pre-bankruptcy course, you prepare a personal budget and proposed debt repayment plan for unsecured debts like credit card bills or medical debts. The bankruptcy trustee reviews these documents and verifies their accuracy through bank statements and tax returns before getting approval from a judge.

In most cases, you repay creditors under court supervision for five years. After completing the program, a judge will dismiss all qualified debts included in the bankruptcy.

What Court Oversight Looks Like

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The bankruptcy code requires you to use 100% of your disposable income to repay creditors. Courts consider disposable income as any monies remaining after subtracting allowable expenses from your gross monthly income.

You receive an allowance for personal expenses such as food, clothing, housing, utilities, and transportation. The courts also allow payments for involuntary payroll deductions, life insurance, court-ordered fees like child support, along with approved childcare expenses, and health care costs. All remaining money must repay creditors included in your bankruptcy filing.

Each year, you must submit tax returns to the bankruptcy trustee, who can modify your plan if your income increases. You can also request a plan modification if your financial circumstances further deteriorate.

The courts retain control over your income, spending, and finances until you complete the program, which could prevent you from making contributions to your retirement accounts, take a vacation, or spend money on other things. The trustee must also approve any new debt.

An unexpected expense that prevents you from making payments could lead to the dismissal of your case, forfeiting any debt discharge. If a judge dismisses your case, there is a mandatory waiting period before you can refile.

The Cost of Filing Chapter 13

The court fees for Chapter 13 remain low at $310 plus a bankruptcy trustee fee of $15 or $20.The highest cost is attorney fees, which typically run between $3,000 and $4,000. Filing without an attorney can put you at a disadvantage because of the complexity of the process and lead to higher monthly payments or your case’s dismissal.

Chapter 13 and Your Credit

Credit reports track your payment history for seven years, beginning with your first late payment, provided you never bring the account current.

The clock starts for the bankruptcy on the filing date and will remain for seven years. Filing bankruptcy does not alter the seven years of reporting, nor does it change the delinquent accounts’ reporting on your credit report.Creditors will continue to report the individual accounts included in bankruptcy along with the bankruptcy itself.

A bankruptcy discharge occurs after making five years of payments, giving you two additional years of reporting before removing the information from your credit file.

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Final Thoughts

The 1000-foot view of Chapter 13 and debt settlement has some resemblances. You make monthly payments through an intermediary and pay less than the full balance owed. However, upon closer examination, it is easy to see that unless you need to protect your home from foreclosure, the strict oversight required could keep you in financial straits for five more years.

Debt settlement offers less stringent repayment requirements, gives you more control over your monthly contributions, and does not penalize you if you miss a scheduled payment.

Lastly, because of the high legal fees in bankruptcy, you could spend less and have more control over your finances through debt settlement even after including debt settlement program fees.

  • How much does Chapter 13 bankruptcy cost?

    Courts set the filing fees at $310, plus a fee to the bankruptcy trustee. The bulk of the cost is attorney fees, which could surpass $4,000 if you have a complex case.

  • How long will a Chapter 13 affect my credit?

    Chapter 13 remains on your credit for seven years from the filing date. Creditors may also continue to report individual accounts as delinquent for seven years from the original delinquency date, provided the account was never brought up to date.