Chapter 13s last either three (3) years or five (5) years depending on a households income at the inception. That is quite a long time and it can be easy to let it fade into the background of one’s mind after settling into the rhythm of monthly payments to a Chapter 13 trustee. A debtor in a Chapter 13 likely had considerable contact with their attorney at the very beginning of the case, but this becomes less and less frequent after the plan is confirmed and all the claims have come in. After a couple of years, some old habits can creep back in, and the debtor may never think to contact their lawyer when faced with certain financial decisions.
Many of my Chapter 13 clients come to me to help save their home from foreclosure. A Chapter 13 is a grand tool for just such a thing. Most of these clients got to the point of facing a foreclosure action in State court because they made choices between paying a house payment and getting needed car repairs or paying for a necessary medical procedure. That first time of missing the payment, they likely started getting some calls, but nothing earth shattering happened. Next thing they knew, several missed payments have racked up, they are served with a civil summons, and the only way to catch them up is through a five-year Chapter 13.
Then Christmas rolls around that second year into the Chapter 13 and the belt-tightening budget worked out with the trustee really only left room for macrame’ gifts for the children or perhaps a Chia pet or two. It is heartbreaking for a parent when their children’s friends are getting the newest iPhone or PlayStation 4. Perhaps the car broke down again or the refrigerator they had been nursing along for an extra 10 year lifespan finally goes out. Well, that old pattern kicks in and it seems pretty harmless to miss a house payment. After all, nothing bad happened before until a good six months down the line. Well, bankruptcy is a different world.
Most home loan creditors will file a motion for relief from the automatic stay (the law that precludes them from going ahead with the foreclosure once bankruptcy is filed) with just one or two missed payments post-petition. Being in Chapter 13 basically puts them on high alert and they are much quicker to pull the trigger.
This is not the end of the world – yet. Their attorney can object to the motion and almost always work out an Agreed Order to get caught back up again in about six (6) months. However, there is a hefty price to be paid. The creditor will add in their own attorney fees and they will also likely insist on a drop-dead provision where if those payments do not roll in on time, the stay will be lifted without filing another motion and they can then proceed with the foreclosure.
The better course of action is to call one’s bankruptcy attorney to do some problem solving when an unforeseen expense comes about. In the Eastern District of Kentucky, the Chapter 13 Trustee typically does not oppose a motion to suspend plan payments for a month or three if there is a good reason. That is often enough to get past some unexpected expense and get back on track making up the payments. The upside to this is that the debtor will not get hit with hundreds more in attorney fees or end up on a probation sort of situation. So, even if it has been a long time since you talked to your bankruptcy attorney, if things go awry, call them first and get help.
You home is an incredible source of collateral for loans when there is equity (value minus debt secured against it), but there is also danger in using your home this way. There are still lenders who will do rather large, short-term loans secured against a private residence. These loans can be tempting because they often will provide for relatively low-interest loans. However, they can be dangerous. especially when they are balloon loans. Such loans are seductive because they have low monthly payments with a final huge payment due at the end.
I have seen these often used by people trying to get a business venture off the ground. However, people sign up for them for many reasons. The business folks are essentially betting on having a solid and very profitable business going in three to five years. I admire their confidence, but most businesses that survive take three years just to start making a modest return. And so, many find their balloon payment looming without adequate resources to cover the debt. Sometimes banks will roll it into a new loan, but there is no guarantee of this. Therefore, it is wise to talk to a lawyer who knows about bankruptcy prior to that maturity date.
Banks like loans against your personal residence because the revisions to the bankruptcy code back in 2005 gave special treatment to loans secured solely against one’s residence. Basically, 11 USC Section 1322(b)(2) prevents such loans from being modified in a Chapter 13 bankruptcy. Therefore, the only thing one can do is cure the arrears through the bankruptcy, but the underlying agreement remains intact. There is a nice little exception, though, found in 11 USC Section 1322(c)(2) for loans that come due DURING the Chapter 13. So, if one times things right and files a Chapter 13 BEFORE the last payment on your short-term loan is due, a Debtor CAN modify that loan to some extent.
The most likely use for this exception is to move the maturity date of the loan out for the duration of the Chapter 13 plan and thus provide for the cure of arrears on that loan. The Debtor still has to show that the lender is adequately protected, but that hurdle is usually overcome easily with real estate that is either holding its value or increasing in value. This is NOT a complete remedy, but it can buy more time for a Debtor to either find alternative financing that has no balloon payment or make those profits they hoped for that would cover the debt.
I was wrapping up final preparations on a Chapter 13 petition and proposed plan today for filing next week. As I ran through the plan and made provisions for the adequate protection payments (in this region they are typically 1% of the value of depreciating assets), I realized it would be some time before I began getting paid for my work. You see, in a Chapter 13, one can put much of the attorney fees into the plan to be paid as administrative costs. This is a priority class of creditors that can be paid in full through the course of the plan. As a priority class, that also means they can be paid ahead of many other kinds of debt.
However, they do not get paid ahead of adequate protection payments. I had been very diligent in this person’s plan to make their budget workable so they could keep their family running while still saving their house and paying off the family car. That car, a family vehicle worth over $10k, meant that adequate protection payments would be over $100 per month right out of the gate. However, due to repaying some retirement plan debts (allowed to avoid tax penalties) their first several months of plan payments would not be much more than the adequate protection amount.
I breathed a sigh and reassured myself that it was just a matter of time and I would be compensated for the post-petition work. I felt good that I was helping the family and that they would be able to cover the arrears on their house and stave off foreclosure. And, I made a mental note that in the future I needed to be mindful of high value cars and tight budgets so that I asked for a smidgen more in up front fees on such matters.
This is a round about way to explain why, in discussing a Chapter 13 with your attorney, she or he may seem to waffle a little on the attorney fees. There is a $3,500.00 “no-look” fee in the Eastern District of Kentucky. This does not mean that is a set, required fee. Rather, if your attorney charges that much or less, the court is not going to ask your lawyer to prove up the time she or he spent as an attorney. If more is charged, then an application detailing the work must be produced. Most attorneys will charge the $3,500.00. Where the waffle comes in is how much will be required to be paid up front prior to filing. I tend to go on the low-end because I know things are so tight for people and I make it as affordable as a Chapter 7, but I have to off-set that with the demand of my own expenses.
A couple of days ago I wrote a post about refinancing your home loan during an active Chapter 13. In that post I addressed the issue of how such refinancing impacts your budget and plan payment. You need to think long-term in refinancing, because your will not be able to hold onto the savings from the lower mortgage payments. This is aggravating, but benign.
There is a much more sinister trap that refinancing can land you in. You need to be careful when looking at refinancing within an active Chapter 13 as to how to any existing arrears on the original loan are treated. If you are paying substantial arrears through the plan, but refinance, then those pre-petition arrears are most likely to be paid off with the new loan. Essentially, a lender with arrears is not going to release their lien to allow a new lien to take priority over theirs until all sums due are paid. This includes those arrears.
If that happens, then your plan payment is still going to be just as high or higher depending on your new loan payment. But, where a certain amount of those payments were going to pay off the arrears at zero (0%) percent interest, now you will be paying interest on the same arrears in the new loan. Not only that, but the percentage of your plan going to unsecured creditors will likely increase significantly. This may all be fine with you if your heart’s desire is to pay as much of your debts as possible. However, it needs to be a conscious decision rather than one your stumble into.
So, if you are paying $10,000 in arrears at 0% interest in the plan on the original loan and then refinance, the $10,000 arrears gets “paid” from the proceeds of the new loan. Your principal is now $10,000 higher than on the original loan, but your plan payment stays the same or higher. You essentially just cost yourself $10,000 plus interest. Your may not feel it, though, because the actual month to month cost remains relatively stagnant.
When looking at refinancing, it is best to look at all factors to make a wise decision: new interest rate and savings from that, length of time left on mortgage, amount of arrears in the plan, and how much additional interest you will pay if the arrears are then out of the plan and in the new note.
In a Chapter 13, the debtor puts together a budget they present to the court. This budget encompasses Schedule I (income) and Schedule J (expenses). In order to get a Chapter 13 plan confirmed, it has to be feasible. Part of showing that a plan is feasible involves demonstrating that the debtor can actually make the payments proposed by the plan. If the money left over (the disposable income) when expenses are subtracted from income is substantially less than the proposed plan payment, then the plan is not feasible.
Sometimes the plan calls for payments that are just a bit of a stretch for debtors. This happens when the debtor is using the Chapter 13 to pay off arrears on a house facing foreclosure or when there is priority, non-discharged income tax debts that have to be paid in full during the plan. In these instances, the debtor and their attorney will likely engage in “belt-tightening” by shaving off amounts from expense items that they believe they can realistically accomplish.
However, there is a source of disposable income that may be lying hidden in all the paperwork. Many people over-withhold on their taxes. Some do this to avoid owing a tax debt at the end of the year and others like to have a self-created bonus. This latter practice is essentially loaning the United States government money for several months at zero percent interest. So, while it is a nice little psychological trick to force one to save money up, it is definitely not maximizing use of one’s resources.
Worst of all, if you have engaged in the belt-tightening on your budget as I mention above then you have created a set-point in the eyes of a trustee. They assume that is your actual budget. So, when they see tax refunds exceeding $1,200.00 per year (state and federal combined), then you belt-tightening budget may backfire.
Let me unpack that a little. In my hypothetical scenario, the debtor gets back an average of $3,600.00 per year in tax refunds. That comes to $2,400.00 more than the threshold that many trustees look too for reasonable withholding levels. This is $200.00 per month. The trustee would argue, and rightly so, that if the debtor used the proper withholding levels, they would have $200.00 more in pocket each month.
Now, in order to achieve the $200.00 plan payment needed to pay off the arrears on the house during the five-year bankruptcy, the debtor “shaved” expenses down by $200.00 each month less than actual expenses. This makes the budget really tight and barely sustainable, but the debtor thinks they can manage it. However, at the meeting of creditors, the trustee challenges the tax refunds and insists on a $400.00 per month plan payment reflecting what the debtor proposed plus the $200.00 per month that has been withheld in excess of taxes actually owed.
A quandary develops. The only way to preserve the $200.00 plan payment is to go back and amend Schedule J to show actual expenses. Ah, but that set-point I mentioned is already established. Now, the debtor will have to produce documentation to support higher expenses than they originally claimed (under oath I might add). Most people do not keep records accurate enough to document all their expenses.
So, if your attorney suggests that you plan to change your withholding on taxes so that less is taken out of your paycheck, trust them. This will allow you to set expenses at reasonable, sustainable levels from the very beginning and yet meet the needs of the plan. Honestly, $200.00 more in hand each month is exactly the same as $2,400.00 once a year. Actually, it is more because when you let that money build up with the Internal Revenue Service, you are losing a tiny bit of the “time value” of those dollars.
I spoke previously about objecting to a claim filed in a Chapter 13 bankruptcy as it relates to “cramming down” or “stripping off” secured debt. In that article I explained the role of creditors’ claims, so I will not elaborate on that here. A more pressing reason to object to a claim filed is if your Chapter 13 plan calls for unsecured creditors to be paid in full. This is referred to as a 100% plan.
I suppose the first thing to explain is why anyone would bother filing bankruptcy if they can pay their creditors in full. Essentially, Chapter 13 bankruptcy forces all creditors to play ball by the same rules. It puts each creditor on the same footing within their class. If you have one creditor who is pursuing a lawsuit or post-judgment collection activities, such as wage garnishment, the debtor may not have the resources to work things out with other less aggressive creditors. The debtor essentially enters into a “debt” spiral because they can only deal with one or a few creditors at a time instead of a global resolution of debt with all creditors. Chapter 13 stops the debt spiral and makes that one or few aggressive creditors operate under the same plan as all the other creditors. So, a 100% plan can allow a global resolution of debt in an orderly fashion rather than a rush to the courthouse by aggressive creditors.
Another benefit to the 100% Chapter 13 plan ties in with the one just discussed: payments can be spread over five (5) years. A debtor who could not afford to make large payments to a creditor that demands being paid in full in just one year very well be able to afford to pay in full over the five-year period of a Chapter 13 plan. An additional benefit is that people are facing interest rates that of 29% (usurious in my opinion), but under a Chapter 13 payment plan unsecured creditors cannot demand payment of the post-petition interest. Along these same lines, the debtor may have fallen behind on secured debt payments, such as their house payment. Their mortgage company may demand payment in full immediately or they will foreclose on the property. Under the Chapter 13 plan, the arrears can be spread over the plan period.
So, a 100% Chapter 13 plan can provide for the orderly resolution of debt, halt exceedingly high interest rates, and avoid the spiral of debt. This brings up to the reason for objecting to claims in a 100% plan: you can also pay off a 100% plan early! Simply put, if you have $50,000.00 in unsecured debt, but only $30,000.00 worth of claims are filed, the Chapter 13 payment that would resolve the debt in full over five years may allow you to be finished in only three years. This gives impetus to examining creditor claims closely in a 100% plan, because if some of the amounts owed are inflated or unsupported, an objection could allow you to be done early with your bankruptcy.
Claims play a major role in Chapter 13 bankruptcies. They are essentially superfluous in a “no asset” Chapter 7 so they are often not filed in such cases except for secured creditors. If there are non-exempt assets that will be liquidated in a Chapter 7, then it is an “asset” Chapter 7 and claims serve a similar function as I’ll describe for the Chapter 13.
In a Chapter 13, a plan is proposed by the Debtor that spells out what the Debtor will pay in over time. The plan also describes how various creditors will be treated. Some districts, such as the Eastern District of Kentucky, treat provisions of the plan as motions that become orders of the court once the plan is confirmed (blessed by the court). In such districts the plan provisions can “cram down” or “strip off” liens by secured creditors based on the value of the asset they have a lien against pursuant to 11 U.S.C. Section 506. However, I am venturing a bit off of the topic of claims.
For a creditor to actually receive what is owed to them per the plan, they must file a claim. There is a form available just for this purpose and the creditor can either send it in to the court clerk to be electronically filed or, if they have set up an account, they can electronically file it themselves. The claims for most creditors (other than governmental agencies) must be filed by a deadline specified in the Notice that is sent out to all creditors when a bankruptcy is filed. If they miss the deadline, their claim will likely be denied and the full debt discharged as to the Debtor.
The claim also puts the Debtor on notice of any additional fees and penalties that the creditor may be entitled to receive under the loan contract or by law. It is up to the Debtor to review the claims and object to anything that is erroneous or to excessive fees. It is also good practice to object to secured claims if the plan calls for them to be crammed down or stripped off. The reason to object to claims is because they are presumed to be sufficient proof, on their face, to establish the existence and amount of a debt. This is because there are hefty penalties to filing false claims. In the next post I will give a little more detail as to when it is beneficial to object to a claim.
A common question when looking at filing for Chapter 7 bankruptcy is whether a debtor can keep their car. If the car has equity, then to keep the car it must be covered by an exemption. There is a specific exemption for a vehicle under Federal law, but one may also use any excess “wild card” exemption. The Federal exemption is at least $3,675.00 in equity (it goes up most years).
If the car has a secured loan against it then to keep it in a Chapter 7 one typically will have to reaffirm the debt. This means that the debtor will have to agree to remain personally liable on the loan as it existed when the bankruptcy was filed. Sometimes creditors will not insist on the reaffirmation so long as the loan is not past due and the debtor keeps making payments on time. However, many of these loans are for much more than the car is worth and have exceedingly high interest rates.
Another way to keep your car in the Chapter 7 is to file a Motion to Redeem Personal Property under 11 USC Sect. 722 of the bankruptcy code. Essentially, the debtor is moving to court to let them pay fair market value of the car in one lump sum as opposed to the full amount of the loan. If granted, then the creditor must release the lien on the car for the lump sum payment.
You may have enough exempted funds in a bank account to pay the lump sum, or you may have to seek a “722 loan” from another source. Either way, this is a good option for a vehicle that is upside down on its loan or has a high interest rate.
The major driving force in determining what your Chapter 13 bankruptcy plan payment will be are your household income minus reasonable and necessary expenses, at least in the Eastern District of Kentucky. I encounter two general situations when looking at household income and expenses to determine what a debtor’s plan payment will likely be in a Chapter 13: 1) people who have constrained their expenses to an unsustainable point in order to try to stave off bankruptcy, and 2) people who find it very challenging to tighten their belt.
The first scenario can show up different ways. They may have stopped paying into voluntary retirement plans in hopes to make things work. Or, perhaps they went against personal convictions and stopped tithing to their church believing it would be a short-term constraint. With these two approaches, they are essentially locking themselves in to being unable to go back to tithing or retirement funding for the three to five-year duration of their Chapter 13. This is because the Chapter 13 trustee will expect documentation of consistent and ongoing tithing or payments into retirement. This is to preclude people who suddenly decide to do these things just to help their own bottom line as opposed to a conviction or long-held practice. The remedy for this requires very early bankruptcy planning and is not easily fixed; it often must be lived with for the term of the bankruptcy.
The second scenario is easier to fix, but tougher for debtor’s to swallow. Those who most often find themselves in this situation have had a healthy income for a long time and unforeseen circumstances, like job loss, drop them into a very constrained income. Most people expand their spending to fill up their income. This is not wise, but it is terribly common. Once certain “luxuries” become routine expenses, it is incredibly hard to reverse them. I see this with higher food expenses for top-of the line organics and fresh food, health supplements, or personal training expenses. Other ways it manifests are in high-end clothing or nice (“dependable”) cars. The remedy is simple: cut expenses. However, it is tough to swallow the idea of trading in the expensive SUV for an old economy car. It is hard to cut food costs without buying processed food. Hard won fitness is hard through personal training is hard to exchange for a modest gym membership and self-training.
However, to get the discharge of debt and relief from foreclosure that Chapter 13 offers, tough decisions and sacrifices must be made.
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.
- What your bank CAN and CANNOT do when you file bankruptcy
- Tax Time!
- Interest Rates on Secured Claims in Chapter 13 Cases in the EDKY
- CAUTION: Tax Refund
- When Business Owners Should File Bankruptcy
- To File or Not to File: Attorney decision making
- Deadlines for Filing Prepetition Tax Returns in Chapter 13 Cases
- Delinquent Property Tax Claims in Chapter 13 Cases
- Lessons Learned the Hard Way
- Miscellaneous Hot Topics in the EDKY
- ‘Tis the Season
- How to Choose a Bankruptcy Lawyer
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