New Laws Make Chapter 13 Bankruptcy Tougher
From the Nolo.com Debt & Bankruptcy CenterLegislation in Congress to "reform" bankruptcy would affect those filing for Chapter 13 bankruptcy.
Updated July 9, 2001
Congress has passed legislation making major changes to Chapter 13 or "reorganization" bankruptcy, and the President has promised to sign the bill into law.
People who file for Chapter 13 repay part or all of their debts over three to five years. At the end of the repayment period, most remaining debts are wiped out. The new law will make plans last longer and payments higher, and will keep some people from filing at all.
Many other changes in the new law will affect all bankruptcy filers, including people who choose Chapter 13 bankruptcy.
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Lower Allowances for Expenses, Higher Payments to Creditors
| Losers: | People who have high living expenses or who reside in an area with a high cost of living. |
Debtors must pay all of their "disposable income" into their Chapter 13 plans. Currently, disposable income is calculated by subtracting reasonably necessary expenses from income. The bankruptcy court determines whether expenses are reasonable.
Under the new law, if the debtor's household income is more than the state median income, the court's discretion on whether certain expenses are reasonable will be replaced by stringent guidelines established by the IRS for each region of the country. Many debtors, especially those who live where the cost of living is high, will find it very difficult, or impossible, to keep their expenses within the guidelines - meaning Chapter 13 bankruptcy will not be a realistic option.
Longer Repayment Plans
| Losers: | People who earn an above-average income and don't want to be strapped with a repayment plan for five years. |
Under current law, the typical Chapter 13 repayment plan is for three years, although some last as long as five years. The new legislation would increase the standard length to five years for people who earn more than the state median income for their family size. This would require them to pay back a larger portion of their debts.
The state median income for a family of four ranges from approximately $43,000 in New Mexico to $75,000 in Connecticut.
No Reductions for Vehicles that Have Depreciated
| Losers: | People who bought a car a few years before filing for bankruptcy and owe more than the car is worth. |
Under current law, debtors can reduce the amount they pay on a secured debt (a debt that is guaranteed by property) if the value of the property has gone down, and they now owe more than the item is worth. Typically, that happens with cars, which usually depreciate rapidly. For example, if you owe $13,000 on your car note, but your car is worth only $10,000, you would have to pay the creditor only $10,000.
The House bill eliminates this rule for debts incurred to purchase an automobile within five years of a bankruptcy filing. The Senate bill applies a three-year rule. (Congress will work out this difference in conference.) In those situations, the debtor must pay the entire debt, regardless of the value of the property.
Higher Plan Payments for Those With Lots of Home Equity
| Losers: | People with more than $100,000 or $125,000 of equity in their home and who live in a state that currently allows debtors to keep that amount of equity. |
Under current law, debtors must repay to unsecured creditors at least the amount of their "nonexempt" property. Each state lists property that is exempt or protected in bankruptcy, either fully or partially. So in states that protect a large amount of home equity (thus decreasing the amount of nonexempt property), plan payments are not as high.
The House bill caps the amount of equity debtors can protect in their homes at $100,000 if the home was bought within two years before filing. The Senate bill caps the amount at $125,000, no matter when the home was purchased. Because President Bush opposes these caps, their future is uncertain. If the caps do survive, people with large amounts of equity in their homes may find themselves making higher plan payments than they would under the old rules.
Only One Chapter 13 Case Every Few Years
| Losers: | Those who want to file more than one Chapter 13 bankruptcy within five years. |
Under current law there is no limit to the number of times people can file for Chapter 13 bankruptcy. In theory, someone could finish one case and file another one two days later. The new House bill would allow only one Chapter 13 case every five years. The Senate bill would allow debtors to file another Chapter 13 bankruptcy two years after a previous Chapter 13 discharge and three years after a previous Chapter 7, 11 or 12 discharge.
Fewer Debts Wiped Out
| Losers: | People who recently bought luxury goods or received cash advances, people with debts incurred through fraud, people owing damages from personal injury or death lawsuits. |
Currently, one of the most attractive features of Chapter 13 bankruptcy is that, unlike Chapter 7, almost all debts that are not paid back through a court-approved plan can be wiped out. For example, debts incurred through fraud, to buy luxury goods and for most taxes, which are not wiped out in Chapter 7 bankruptcy, are cancelled at the end of the Chapter 13 repayment plan. The new law greatly expands the number of debts that cannot be cancelled in Chapter 13 bankruptcy including:
- Debts obtained through fraud or false statements
- Debts to purchase luxury goods or services (such as vacations and expenses for hobbies or entertainment) shortly before filing
- Cash advances of $750 or more incurred shortly before filing, and
- Debts for restitution or damages in a civil case for willful or malicious conduct by the debtor that caused personal injury or death.