You’ll likely be much more comfortable with the Chapter 13 “adjustment of debts” procedure once you read this story about how it plays out.
Chapter 13 can be pretty mysterious. And confusing.
A big part of the confusion probably arises from how flexible of a procedure it is. It covers situations all the way from those in which all the creditors are paid in full to those in which most creditors receive nothing or very little. It can be a sensible backup plan if you don’t qualify for Chapter 7 because of too much income or too much assets, but may also be the best solution if your income is quite low and you have very little in assets. It can be the way to go if you have just a mortgage problem, or an income tax problem, or a child support problem, or a student loan problem, or a divorce debt problem, OR any combination of thes. All this variety can make it hard to get a handle of how it would work for you.
The following example will walk you through a case from beginning to end, a relatively simple one to help you see what is involved and how it usually plays out.
The Example
Andrew and Amanda, a couple married 15 years with two children, have the following debts:
- A $200,000 first mortgage on a home presently worth $195,000, with back payments owing of $15,000 on payments of $1,500 per month, and a foreclosure pending.
- A $45,000 second mortgage on the same home, with back payments owing of $6,000, on payments of $400 per month.
- A IRS income tax debt of $3,000 for the 2009 tax year, another $3,000 for 2010, and $2,000 for 2011, totaling $8,000.
- Credit card and other various unsecured debts totaling $60,000.
Their Dilemma
Amanda and Andrew both had periods of unemployment and/or underemployment during the past several years—the reason that they are behind on their mortgages and income taxes. But they’ve now been working steadily for the last six months in jobs that look like they will last. But they only make enough so that they could afford the monthly payments on the first and second mortgages, with very little left over to pay their back taxes and other debts, much less catch up on their huge mortgage arrearage. They worked out their budget and figure they can sensibly pay about $125 to all their creditors beyond their first and second mortgage regular monthly payments. But that seems like nothing for catching up on $21,000 in the two mortgage arrears, $8,000 in back income taxes, and $60,000 in other debts. They would very much like to save their home because they’ve raised their kids there and love their schools and the neighborhood, but figure it’s hopeless. Besides they wonder even if somehow there was a way to keep their home whether it would even make sense to struggle to do so since they owe $245,000 on a house worth only $195,000.
The Chapter 13 Option
But when they go see a bankruptcy attorney, Andrew and Amanda are almost shocked to hear that they DO have a very manageable way to keep their home. And while doing so, they can simultaneously also take care of their tax debt, and their many other creditors, all within a very sensible budget and within a reasonable time.
Their Chapter 13 Plan
The couple learns that to accomplish this, Chapter 13 “adjustment of debts” gives them the power to do the following, most of which would not be available under Chapter 7 “straight bankruptcy”:
- Stop the foreclosure permanently and require the first mortgage holder to accept payments on the $15,000 of arrearage stretched out over the course of 3 to 5 years.
- “Strip” the second mortgage off their home, with the result that they 1) no longer have to pay the monthly $400 monthly payment, 2) don’t ever have to pay the $6,000 in arrearage, and 3) not have to pay most or any of the $45,000 balance.
- Stop the IRS from taking any collection action against them and 1) avoid the accruing of interest and penalties going forward, 2) no long have to pay most or any of the $3,000 in 2009 income taxes, and 3) require the IRS to accept payments on the $5,000 in 2010 and 2011 taxes stretched out over the course of up to 5 years.
- Not pay most or any of the $60,000 in credit card and other unsecured debts.
Amanda and Andrew are delighted to find out that by making Chapter 13 plan payments of $525 per month—the amount of their $400 second mortgage payment they no longer need to pay, plus the $125 beyond that was in their budget for creditors—they could accomplish all this.
The next few blog posts will show how this Chapter 13 plan pencils out and the steps for turning it into reality.