How Does Filing Chapter 13 Bankruptcy Work?

Chapter 13 bankruptcy is a type of personal bankruptcy where a consumer is allowed to reorganize their debt and pay off some or all of the debt over three to five years. The consumer is obligated to turn over to the courts all of their disposable income during this time until their debts are officially discharged. Since the new bankruptcy law changes in 2005, unfortunately more and more consumers are being forced to file Chapter 13, instead of Chapter 7, where debts are generally wiped out completely. On the bright side, different consolidation services like credit counseling and debt settlement, also known as debt negotiation, are available for consumers with unsecured credit card debt.

Versus Chapter 7

Most experts agree that Chapter 7 is the preferable type of personal bankruptcy. As mentioned above, Chapter 7 can discharge a consumer's debt for free in many cases (minus attorney's fees of course), whereas a Chapter 13 plan requires that people pay some or all of their debt back. Despite the fact you are paying the debt back under a Chapter 13, the debts are still never considered satisfied, and it will be reported as such for up to 7 years to the credit bureaus (Chapter 7 stays on your credit for 10 years on the other hand). Both will stay on legal records for up to 20 years. The only real advantage of Chapter 13 is that you can include back payments on secured debts (like your mortgage or auto loan) in this type of plan. Due to the devastating financial and credit effects of both Chapter 7 and 13, both are considered a last resort for debt problems.

Compared to Getting a Debt Consolidation Loan

Debt consolidation services, like debt settlement and credit counseling, are great options to help consumers avoid bankruptcy. Debt consolidation loans, on the other hand, tend to be a riskier and less financially savvy option for many consumers. There are several disadvantages of using a consolidation loan to avoid Chapter 13. First and foremost, if you are considering Chapter 13 chances are you are fairly overextended with your debts. Given the fact that many loans will necessitate that you attach collateral in order to qualify, this is an extremely risky premise (or you may not be able to qualify for a loan if you don't own a home). Think about it: you're risking your home or other property when you've already shown that your debt load is too much.

Against Debt Settlement & Negotiation

Credit card reduction through settlement and negotiation is generally a better alternative to filing Chapter 13 for unsecured debt. There are several reasons: 1) Debt settlement does not have the same catastrophic effect on your credit. No doubt negotiating your debts will impair your credit score, but the negative effect will undoubtedly be preferable to that of Chapter 13. After all, your debts are ultimately satisfied. 2) Settlement could potentially save you more money. 3) Debt negotiation does not require a court trustee to monitor your disposable income and expenses, so it tends to be far less intrusive. 4) You do not have to attach your property in order to qualify for a settlement program, so your home is never at risk.
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Or Credit Counseling

The underlying concept behind credit counseling is very similar to Chapter 13 bankruptcy. In essence, you reorganize your debts to presumably lower and consolidate your monthly payments. The obvious advantage of using a credit counseling service is that the credit damage will be far less catastrophic than filing Chapter 13. The payments in credit counseling can oftentimes be too high for someone who is considering bankruptcy, but it is still worth investigating. If your concern is a very low monthly payment without bankruptcy, credit card settlement is probably your best option.  

Frequently Asked Questions

What types of debts can be included in a Chapter 13 arrangement?

Generally, most credit card debt, medical bills, deficiency balances from repossessions, collections accounts and legal judgments can be included in a Chapter 13 plan. This means that by including these accounts, they will be eliminated once they are formally discharged upon completion of the plan, regardless of whether you paid them off in full.

What kind of debt cannot be completely discharged unless paid in full?

Generally, student loans (both federal and private, thanks to the new bankruptcy laws), back taxes, court fines, child support, alimony, and debts from a civil judgment for things like drunk driving or other reckless or malicious acts.