There are many misconceptions that surround Chapter 13 bankruptcy. Many of the potential clients I meet mistakenly believe that they must pay back 100% of their debt in a Chapter 13, with interest.
While it is true that Chapter 13 cases can be challenging, there is nothing in the Bankruptcy Code that requires a 100% payout to all creditors. Some debts must be paid in full – generally these are secured claims, such as missed mortgage payments, car loans, furniture loans and other debts that are tied to specific property. Most (but not all) tax claims must be paid in full as well.
Unsecured debts – which includes credit card bills, medical debt and signature loans – need not be paid at 100%. In fact, I frequently file Chapter 13 repayment plans that call for 50%, 25%, or even 1% payments to unsecured creditors. This means that if you enter Chapter 13 with $50,000 in credit card debt, you may pay back as little as $500 over a 5 year period and that credit card lender is forever discharged.
Further, unsecured creditors are not entitled to interest on their claims. Many of my clients are driven into bankruptcy by unmanageable credit card debt that keeps building and building, because the interest rate on this type of debt can be 20%, 25% or higher. Credit card interest can trap you into an endless cycle of debt – if you want to see how it works, enter $10,000 into an online debt calculator and choose “make minimum payments only.” A $10,000 debt at 25% interest will take almost 30 years to pay out, and you would end up paying $20,000 in finance charges.
In Chapter 13, however, credit card lenders file their claims and they get paid only on the balance at the time of filing with no interest. This fact alone can save you tens of thousands of dollars. If you plan pays 1% or even 10%, you will discharge (wipe out) thousands of dollars of debt. Finally, credit card lenders who do not file a proof of claim on time will lose their right to participate in your Chapter 13 payout completely. And if you successfully complete your plan, your credit card creditors will be totally discharged, even if all they got was 1 penny on the dollar.
Chapter 13 has its issues – 5 years is a long time to subject yourself to bankruptcy. But if you cannot fit into a Chapter 7 and mounting credit card debt with outrageous interest is driving you to financial ruin, Chapter 13 might be a way out. Remember, Chapter 13 discharges carry the force of law – the reduced payout to credit card lenders is not voluntary and unlike debt management plans, interest is not in the equation.