Kentucky Bankruptcy Law

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No need to fear 13 (Chapter 13 that is)

Many people in debt feel overwhelmed when looking a filing a chapter 13. As much as five years of plan payments seem daunting and having to seek approval of incurring new debt seems intrusive. However, a Chapter 13 bankruptcy can often accomplish goals for people who a Chapter 7 cannot. One of the most frequent of these goals is for the debtor to keep their home even though they are behind on payments. To take some of the mystery and fear out of Chapter 13 plans, let’s look at what it takes for a Chapter 13 plan to be confirmed (approved) by the court.

There are four tests that a Chapter 13 plan has to pass in order to be confirmed. First, since debtors often turn to a 13 to save a house with past due payments, the Chapter 13 plan has to account for full repayment on these arrears. In the Eastern District of Kentucky, past due amounts of any secured debt, such as house payment arrears, must be paid through the plan. Your ongoing house payment can usually continue to be paid directly (outside the plan) to the creditor so that you are not also paying the trustee commission on top of the interest. So, if your regular house payment is $1000.00 per month and your loan won’t be paid off for five (5) plus years, you keep paying the creditor directly. But, if you owe $12,000.00 in past due payments on that same house, you will have to pay $12,000.00 into the plan over the course of those sixty (60) months (or $200.00 per month plus trustee’s commission).

Now, lets say you own a car and only have twenty-four (24) months left on the debt. Since this will be paid in full during the duration of the plan, you will either have to pay the entire amount through the plan or make a step up in your plan payment when it is paid off outside the plan. Since you will have to make that step up in payment anyway, you might as well look at paying the entire thing through the plan UNLESS your current interest rate is less than around 6%. So, the first test is that all secured debt is accounted for by the plan with all arrears paid through the plan. I am calling this the “first” test not because there is any particular order, but because most people’s highest priority is keeping their house.

The second test is the “disposable income” (a.k.a. “projected disposable income”) test. Basically, the debtor accounts for their average income (current monthly income) each month and subtracts out their reasonable living expenses. This takes the debtor looking back in time and seeing what they spend on food, clothing, recreation, and various other items. Determining reasonable expenses is probably the place where there are the most challenges by trustees to the plan. If you report expenses that are substantially over the norm for most people living in your region with the same household size and similar income, then your plan will draw challenges. However, if your expenses are in the realm of reasonable, whatever is left over after you subtract these expenses from your income is the disposable income.

The debtor is expected to pay their disposable income into the plan. If your proposed plan payment is substantially less than your disposable income, your plan will not get confirmed. If it is higher than your income minus expenses, then it might also be challenged because the plan has to be feasible that you can actually pay it.

The third test is very straightforward: If you owe priority income tax debt (some tax debt cannot be discharged – this is priority tax debt), then the plan payment must be sufficient to pay all the priority taxes in full through the plan. Federal income tax debt can still accrue 4% interest through the plan and Kentucky tax debt 5%. However, penalties are halted.

Fourth, unsecured creditors in the Chapter 13 must get paid at least as much through the plan as they would have gotten had you filed a Chapter 7. If in a hypothetical Chapter 7 all of your assets were covered by exemptions creating a “no asset” bankruptcy, then your Chapter 13 does not have to pay anything to unsecured creditors (some districts expect at least a small percentage of unsecured debt to be paid, but zero (0%) percent plans have been approved occasionally in Kentucky). Alternatively, if your home (or other asset) that you are wanting to keep has equity that could not be covered by exemptions, then the amount of equity left “exposed” has to be paid to unsecured creditors over the life of the plan.

Let us use the same example as above where a $12,000.00 arrears existed and add that $6,000.00 of equity in the home was left exposed (not covered by exemptions). In this scenario the debtor would have to pay $100.00 more than the $200.00 per month. The $200.00 covers the arrears and the $100.00 takes care of the “liquidation test” and pays the exposed $6,000.00 equity. Now, we have a $300.00 per month payment plus the trustee’s commission.

One has to look at all four tests in concert because if the disposable income is only $150.00 per month but the plan demands $300.00 per month, the Debtor needs to come up with a way to make that $300 payment feasible or make a tough choice of surrendering the home. If, though, the disposable income is actually $400.00 per month but the other tests demand only a $300.00 plan payment, then $400.00 will be the plan payment.

One of the good things about Chapter 13 is that through looking at these tests, the debtor is often faced with making decisions about what expenses can be reduced in order to come up with a plan that can be confirmed. The result of that process is that they sometimes realize there is no way to hang on to an asset, such as a home, with their income. Sometimes, though, they learn how to live within a budget which is feasible and which lets them keep important assets. Either way, Chapter 13 pushes debtors to live within their means far better than a Chapter 7.

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April 17, 2013 - Posted by | Bankruptcy, Chapter 13, Foreclosure, Plan, Plan payments, Planning, Pre-filing planning, Secured loan arrears | , , , , , , , , , , , , ,

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