Does Chapter 13 Reduce Debt?

by Tom Streissguth

If your debts are out of control, you have the option to declare bankruptcy. In a Chapter 13 bankruptcy, a court-appointed trustee draws up a repayment plan. The debtor agrees to turn over excess disposable income to the trustee for payments to the creditors. If the debtor meets the terms of the repayment plan, a Chapter 13 bankruptcy will not only reduce but eliminate all dischargeable debts.

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Repayment Plans

In a Chapter 13 repayment, you send a check every month to the trustee, who repays your creditors according to a schedule drawn up by the court. The court takes into account any income you are earning, and that you expect to earn, when you file the bankruptcy petition. A portion of the total debt is repaid to each unsecured creditor over the course of the plan. Each creditor receives less each month than if the debtor had not filed for Chapter 13 protection, because the debtor's disposable income is divided among all creditors. In addition, all payments go directly to principal, not interest. Each payment reduces the principal balance; even if the bankruptcy is dismissed, the debt will be less than at the start of the case.

Discharge

At the end of the Chapter 13 repayment plan, the court discharges your dischargeable debts. Even if you have not paid down the principle in full, the discharge legally cancels the debt, and the creditor no longer has any claim against you. The creditor writes off the outstanding balance, but also reports the bankruptcy to the credit-reporting agencies.

Secured Debts

Any loan secured by property remains valid when you file for Chapter 13 bankruptcy. The bankruptcy court does not discharge these debts; the creditor retains the right to seize the property if you default on the loan. This includes mortgages secured by property; auto loans secured by your vehicle; or any bank or business loan for which you have pledged assets or property.

Non-Dischargeable Debts

The federal laws governing bankruptcy do not allow certain "priority" debts to be discharged. These include past-due taxes that the IRS or state tax authorities assess; child support or alimony payments set by a marital settlement agreement; criminal restitution fines; or federally guaranteed student loans. Although these debts join the unsecured claims in your repayment plan, they are paid in full. If for any reason the repayments to priority debts come up short, you remain liable for paying any balance that remains.

Dismissal

Many who file Chapter 13 discover that they fall behind on their monthly payments and are unable to fulfill the terms of the repayment plan. The trustee can report a default on the plan, which will either convert the bankruptcy to a Chapter 7 liquidation or he can dismiss the bankruptcy altogether. If your case is dismissed, you are responsible to repay the remaining principal on your unsecured debts; creditors have the right to full repayment, plus interest. If you successfully convert the case to Chapter 7, your unsecured debts will be discharged at the end of that process.