If you’ve learned you don’t qualify for Chapter 7 bankruptcy, perhaps because your income is too high to pass the “means test” or because you recently received a prior bankruptcy discharge, you may feel like you’re out of options. Many people in this position go back to what they were doing before: juggling minimum payments, borrowing against their home, or cashing out retirement savings. Before you go down that road, consider Chapter 13.
What Is Chapter 13?
Chapter 13 lets you repay some or all of your debts through a court-approved plan over three to five years. You make one monthly payment to a trustee, who pays your creditors. When you finish the plan, most remaining qualifying unsecured debt, such as credit cards and medical bills, is discharged. Some remaining debts, like student loans, may not be discharged but you can still use the Chapter 13 to pay down the loans.
The Problem with Minimum Payments
If all you’ve been doing is making minimum payments on credit card balances you’ve probably already learned that strategy gets you nowhere. Minimum payments are designed to keep you in debt. Most of each payment goes to interest, so your debt balances barely move. Paying only the minimum on a large credit card balance can take decades and cost far more than you originally borrowed. In Chapter 13, interest on most unsecured debt generally stops. You often repay only a portion of what you owe, based on what you can afford rather than what creditors demand. You’ll be out of debt in at least five years with Chapter 13, compared to decades or even forever if you just try to pay the debts outside of bankruptcy.
The Risk of a Second Mortgage
Using a home equity loan to pay off credit cards can seem smart, but it turns unsecured debt that can be discharged in bankruptcy into debt secured by your home that can’t be discharged in most cases. If you fall behind, you could lose your house. Chapter 13 works the other way: it can protect your home. It can stop a foreclosure and let you catch up on missed mortgage payments over time. In some cases, a second mortgage that is completely underwater can be “stripped off” and treated as unsecured debt. But using your home’s equity to pay debt should always be avoided if Chapter 13 can help instead.
Why Raiding Retirement Is a Mistake
Cashing out a 401(k) or IRA usually triggers income taxes. If you’re under 59½, you may also owe an early withdrawal penalty. Worse, most retirement accounts are protected in bankruptcy, so you could spend (lose) money creditors could never have reached and still end up needing to file bankruptcy later. Chapter 13 lets you keep your retirement savings for the future. Most financial experts suggest we should all have at least two million dollars saved for our retirement and trusting that Social Security will fund our future retirement is a mistake. So using up retirement funds now to pay debt that could be discharged in bankruptcy jeopardizes your future far more than a bankruptcy filing will.
Debt Consolidation Program Failures
Late night cable channels are filled with commercials for various debt consolidation schemes and companies. You’ll find other articles on this blog about the lawsuits and allegations lodged against them by federal authorities. But I cringe when I hear clients tell me the amount of money they’ve paid these companies over months or years, only to find that they still need to file bankruptcy to discharge debt. Thousands or even millions of dollars have been wasted on these programs by people who found they still had to file bankruptcy when the scheme failed.
Other Chapter 13 Benefits
- Immediate protection: The automatic stay stops collection calls, lawsuits, wage garnishments and repossessions as soon as you file.
- Keep your property: You generally keep your home, car and other assets while you make plan payments.
- Car loan relief: You may be able to lower the interest rate on your car loan and, in some cases, reduce the balance to the vehicle’s value.
- Protection for co-signers: The co-debtor stay can often shield family or friends who co-signed your consumer debts.
A Fresh Start with a Finish Line
Chapter 13 isn’t a second-best option. It’s a structured, court-protected path out of debt with a clear end date. If you don’t qualify for Chapter 7, contact Nancy L. Thompson Law Office of Des Moines, Iowa and ask whether Chapter 13 is right for you.
