Paying Down Your Debts
When you file for Chapter 13 bankruptcy, you enter into a court-approved repayment plan to satisfy your debts over three to five years. You must turn over to the trustee your disposable income each month – that which remains after you pay your reasonable living expenses. The trustee then apportions this money among your creditors. Not all creditors are treated equally, however. Your secured debts – those guaranteed by collateral, such as your home or vehicle – are paid first. Unsecured debts, such as credit cards or medical bills, are last in line. As a result, your secured creditors typically receive most or all of what you owe them, whereas your unsecured creditors may not receive anything at all. They only receive full payment if your disposable income is sufficient to cover 100 percent of your debts over the life of your plan.
With both Chapter 7 and Chapter 13 bankruptcies, debtors have the option of surrendering assets that act as collateral for loans, relinquishing them to the secured creditor. If you file for Chapter 13 and elect not to do this, your ongoing loan payments may be considered part of your reasonable living expenses – you make them outside your plan payments before giving the balance of your income to the trustee. If you're behind with payments, these past due amounts are typically included in your Chapter 13 plan and paid from your disposable income. You may also have the option of making your current payments through your Chapter 13 plan. In any case, the trustee will not liquidate or sell your property to raise money for your creditors because your plan already addresses payment of your debts.
Cramming Down Secured Debt
One of the greatest advantages of filing for Chapter 13, as opposed to Chapter 7, applies to "upside down" loans. This is when your loan balance exceeds the value of the collateral. For example, you might owe $12,000 on your automobile, but its fair market value is only $9,000. In this case, the $3,000 difference – 25 percent of the loan – can be "stripped off" or "crammed down." Your loan is restructured to equal the value of the collateral, so you would only have to pay 75 percent of the debt. Additionally, the bankruptcy court adjusts your interest rate, typically reducing it to something less than you initially contracted for. This rule doesn't apply to all secured loans, however. You can't cram down the mortgage on your residence, unless it's a mobile home. Otherwise, you can only strip off mortgages on a second home or investment properties. This rule also only applies to vehicles you purchased at least 910 days before you filed for Chapter 13. If your asset doesn't qualify for a cram-down, you must pay 100 percent of the loan.
If you only pay a percentage of a secured debt – such as 75 percent of your auto loan – the other 25 percent of the loan balance is converted to unsecured debt. It's treated the same as your credit cards or any other debt that is not secured by collateral. After the trustee pays all of your secured and priority debts, such as taxes or child support, he apportions the remaining money – if any – to your other creditors. If the entire unsecured balance isn't paid off by the end of your Chapter 13 plan, the balance is discharged. Because payments are prioritized in this manner, if no portion of your secured debt is stripped off, these creditors typically receive 100 percent of what they are owed. They're paid first.