Under Chapter 13 some special creditors may be paid in full, while others are paid much less, sometimes even nothing. What determines this?
The Point of Chapter 13 Payments
People are often frightened away from Chapter 13 without a closer look because of the impression that “you have to pay part of your debts” instead “just writing everything off” under Chapter 7. There’s a bit of truth behind this very general statement, but it really misses the point of Chapter 13.
The Chapter 13 “adjustment of debts” is a very flexible and powerful procedure which can do many things that Chapter 7 “straight bankruptcy” cannot. It is often particularly helpful with secured debts—home mortgages, vehicle loans, for example—and special debts that are not discharged (legally written off) under Chapter 7, such as recent income taxes, child and spousal support arrearages, and non-support divorce obligations. Chapter 13 can also be the best way to preserve your property and possessions, or to deal with your debts if you don’t qualify under Chapter 7.
So, often the Chapter 13 monthly plan payments mostly go to pay secured debts for collateral you want to keep like your home or vehicle, and other special debts that you want or need to pay anyway. Or you are paying to protect property that you’d otherwise lose in a Chapter 7 case, or you are in Chapter 13 because Chapter 7 is not an option.
You Don’t Always Pay More Under Chapter 13
It’s possible under certain circumstances that you can actually pay less to your creditors under Chapter 13 than under Chapter 7.
To take a simple example, if you owed $150,000 of debts that could be discharged in a Chapter 7 case but also owed $50,000 in income taxes of the last 3 tax years to the IRS, you would end that Chapter 7 case needing to make payment arrangement with the IRS to take care of those income taxes. You could enter into a lengthy monthly payment plan with the IRS, throughout which time interest and penalties would continue to accrue, amounting to a substantial amount of extra debt owed. In contrast under Chapter 13, usually the tax interest and penalties would stop accruing the date your case was filed. So under Chapter 13 much less would be paid on the income taxes. And assuming that all of the debtor’s disposable income during the case went to satisfy those taxes, leaving nothing left over, those other debts would likely be discharged at the end of the case without having been paid anything. So in this case you would pay less to all of your creditors under Chapter 13 than under Chapter 7.
We admit this is an unusual example, but it illustrates how flexible of an option Chapter 13 can be, and how the amount you pay can go against your expectations, often in a good way.
Factors Determining How Much You Pay
Many factors influence how much of your debts would be paid in a Chapter 13 case. The main factors are your income and expenses, your secured debts and your intentions about keeping or giving up the collateral, any special debts like child support and recent income taxes that must be paid, and sometimes the amount of assets you own that are not protected by exemptions.
The monthly plan payment paid to the Chapter 13 trustee for distribution to the creditors is mostly determined by your projected income and expenses. The expenses used for this purpose are a combination of your average actual expenses for certain expenses and allowed expenses for other ones. An example of the latter is your monthly medical expense based on the IRS National Standards for Out-of-Pocket Health Care. Then the amount of money left over each month is your “monthly disposable income,” which is generally the amount of your Chapter 13 plan payment.
While calculating your “monthly disposable income” from your income and your actual and allowed expenses, you and your attorney may have the opportunity to be relatively tight with some of the expenses or relatively generous with others. This could result in a higher or lower “monthly disposable income” amount. A higher amount may be preferred if you need more money paid into your Chapter 13 plan to pay off some secured or special debt faster, or to do so within the maximum 5-years that is allowed. A lower amount may be preferred if you’d rather pay less to your creditors overall.
How Much Does Each Creditor Get from the Monthly Plan Payment?
This depends on the type of debt: “secured,” “priority,” or “general unsecured.”
How much “secured” creditors get paid is a complicated question with details way beyond the scope of this blog post. But generally if you want to keep collateral you have to pay for the right to do so. Sometimes that means paying the debt in full (especially when the collateral is worth more than the debt), and sometimes in part (especially when the collateral is worth less than the debt). There are exceptions when the lien through which the debt is secured can be “avoided” like certain judgment liens on a home, or “stripped” off a home’s title such as certain second or third home mortgages.
“Priority” debts are ones that the law favors—recent income taxes, child/spousal support arrearage, for example—and generally have to be paid in full during the life of the Chapter 13 case.
“General unsecured” debts are ones that are neither “secured” nor “priority.” They are paid under Chapter 13 usually only to the extent that there is money available from your “disposable income” after the other creditors are paid. But that’s also affected by how long you must pay into your case—a minimum of 3 years or 5 years. (See two blog posts ago about how the length of a Chapter 13 case is determined.) Also, sometimes you must pay more to the “general unsecured” debts to protect an asset, or for various other special reasons negotiated with your Chapter 13 trustee. When you hear “0% plan,” “20% plan,” or “100% plan,” those refer to the percentage of the “general unsecured” debts being paid in the case.
So, you will usually have to pay your “priority” debts in full, your “secured” debts in full or in part depending on a series of special rules, and your “general unsecured” debts depending on how much you have left over. And how much you have left over after paying off your “priority” and “secured” debts depends on how much you are paying altogether into your plan, including how long you must pay your “monthly disposable income.” And lastly, the amount paid to the “general unsecured” debts must sometimes reach a certain minimum threshold as a way of protecting your otherwise non-exempt assets, or for some other negotiated reason.