When you are deciding whether to go into a Chapter 13 payment plan, it’s good to know you have Chapter 7 as a backup.
Chapter 13—Powerful But Uncertain
Chapter 13 is an amazing tool. It can often do much more than Chapter 7 with certain kinds of debts. It can save your home or vehicle, sometimes by reducing how much you need to pay monthly and overall. It can often deal much better with income tax debts, child and spousal support arrearage, and various other special debts.
But Chapter 13 also requires a long-term commitment. The payment plan that you and your attorney propose requires looking into the future. Usually it requires assuming that your income and expenses will stay reasonably steady for at least the next 3 to 5 years. Or it requires predicting your income and expenses that far into the future. Of course life does not always go as planned.
The power of Chapter 13 may encourage people to make decisions which may make sense but involve more risk.
To qualify for Chapter 13 you must be an “individual with regular income,” meaning that your “income is sufficiently stable and regular to enable [you] to make payments under a [Chapter 13] plan.” (See Sections 109(e) and 101(30) of the Bankruptcy Code.) That requirement of a “stable and regular” income is a vague one. It requires you to make a prediction that your income will be “regular and stable” enough into the future.
Bankruptcy courts tend to at least give debtors a chance to demonstrate that their income (and expenses) are stable enough for Chapter 13. If your payment plan is sensible you are usually given the opportunity to see if you can make the payments you are proposing.
So you may appropriately decide to file a Chapter 13 case to be able to do what you otherwise couldn’t do—such as to hang onto your home or vehicle, or gain some other benefit only available under Chapter 13. But then your income may later get reduced, an expected income increase may not happen, or your expenses may unexpectedly increase. So you may need to admit that you could not pay as much as you had expected.
Knowing that Chapter 7 is always available as a fallback option can be very helpful in making a good decision to file a Chapter 13 case.
Chapter 13’s Power and Uncertainty Illustrated
Here’s an example to illustrate how this can work well.
Assume you were $15,000 behind in payments on your home’s first mortgage. The home is worth a little less than the amount owed on that mortgage. And you also have a second mortgage on top of that.
If you filed a Chapter 7 “straight bankruptcy” case in this situation, you’d likely just surrender the home and get out from under those debts. But then you’d no longer have your home.
Chapter 13 gives you the power to “strip” the second mortgage off the title of that home (again, assuming that all of the equity is covered by the first mortgage alone). “Stripping” the second mortgage means you wouldn’t have to pay its monthly payment, thereby significantly lowering your monthly cost to keep the home.
This “stripping” also lowers the debt against the home by the amount of that second mortgage, bringing the home’s total debt down closer to the its market value. Keeping the home is now cheaper and more financially sensible.
However, doing this may still be tough for you financially, no matter how much it saves you. Whether you can pull it off would still depend on all the amount and reliability of your income and expenses. You may understandably be inclined to stretch your budget to try to save your home. That may especially be true if you have strong intangible reasons to do so, such as to keep your kids in the same schools and neighborhood, or because rents are so high in your area.
Knowing that Chapter 7 is a fallback option if for whatever reason you can’t fulfill the terms of your Chapter 13 plan can help you take appropriate risks when filing Chapter 13.
The Right to Convert to Chapter 7
The Bankruptcy Code explicitly states in Section 1307(a) that a Chapter 13
debtor may convert a case under this chapter to a case under chapter 7 of this title at any time. Any waiver of the right to convert under this subsection is unenforceable.
Notwithstanding this very clear right to convert, there can be situations in which the court believes that the bankruptcy laws are being abused and conversion is not allowed. But these situations are rare. Talk with an experienced bankruptcy lawyer about how the local bankruptcy judges are dealing with conversions from Chapter 13 to 7. But in general you can assume that you can switch to a Chapter 7 case, like the statute states, “at any time.”
Applying Our Hypothetical
Let’s look again at the above hypothetical example. Let’s also assume that you have a son or daughter in high school deeply involved in his or her school’s sports or other activities. If you surrender their home and could not afford a rental within this high school’s boundaries, your child may have to change schools, something you very much want to avoid.
You may be really concerned about the stability of your future income. You know that there is some risk in whether you’d be able to pay what need to pay to stay in your home. But you may appropriately believe the risk is worth the opportunity for your son or daughter to complete the year or two of school.
The Crucial Conversion Option
Our last blog post listed some of the potential disadvantages of simply dismissing a Chapter 13 case. Mostly, you immediately lose protection from creditors and your debts are not discharged (legally written off).
Conversion to Chapter 7 avoids those disadvantages. The protection from creditors—the “automatic stay”—continues from the prior Chapter 13 case without a break into the new Chapter 7 case. And at the end of the Chapter 7 case, usually about three months after the conversion, all or most of your debts are discharged.
So, conversion to Chapter 7 can be a decent back-up plan when the goals of your Chapter 13 case can no longer be met. As you’re considering whether Chapter 13 is the right option for you, it’s good to know that if you have a change in circumstances, and/or if you take a calculated risk which does not go your way, you can convert into a Chapter 7 case.