Why Chapter 13 Bankruptcy Is Probably a Bad Idea

Chapter 13 bankruptcy can help some people reorganize and repay debts. Homeowners and people with valuable assets often consider it. But Chapter 13 requires a 3-5 year repayment plan. Many people can’t successfully complete that plan. Filing Chapter 13 without a lawyer is nearly impossible.

What Is Chapter 13 Bankruptcy?

Chapter 13 bankruptcy is the second most common personal bankruptcy type. Chapter 7 remains the most popular option. Chapter 13 is called the wage earner’s plan. It allows people with regular income to reorganize and repay debt. You’ll follow a multi-year repayment plan.

If you successfully complete the Chapter 13 plan, remaining eligible debts are erased. Note that student loans, child support, alimony, and tax debts typically remain. One major advantage: Chapter 13 can help you avoid losing your home. But you need to understand the potential downsides.

Who Should File Chapter 13 Bankruptcy?

Chapter 7 cases resolve much faster than Chapter 13 cases. Chapter 7 wipes out all eligible debt with no repayment required. But not everyone qualifies for Chapter 7. It may not work for people with valuable assets they want to protect.

If you fail the means test, you might have too much disposable income. Chapter 13 could be your alternative. You might also consider Chapter 13 if you have significant home equity. It provides protection against collection actions like wage garnishment.

Chapter 13 offers some benefits. You can catch up on secured debts like mortgage or car payments. It can make monthly debt payments more manageable. If you’re dealing with credit card debt and medical bills, explore other options. Debt management plans, debt consolidation, and debt settlement exist. You can speak with a bankruptcy attorney for free to understand your choices.

What Are the Downsides of Chapter 13 Bankruptcy?

Every bankruptcy type has pros and cons. Chapter 13 has serious red flags you should consider. Understanding these issues helps you make better decisions.

Many Chapter 13 Bankruptcies Fail

A study from the American Bankruptcy Institute found troubling results. Less than 40% of Chapter 13 cases succeed. More than half of filers don’t complete their payment plan. Compare that to Chapter 7: 95% of cases end successfully.

Chapter 7 cases are much simpler and quicker. The main reason Chapter 13 fails? Sticking to a 3-5 year repayment plan is difficult. Most payment plans last five years. A lot can happen in five years.

People’s financial situations change unexpectedly. Job loss, medical bills, and unexpected expenses happen. If you miss your regular monthly payments, consequences follow. The bankruptcy trustee can ask the court to dismiss your case. No debt gets discharged. You lose bankruptcy protection and still owe your debts.

Chapter 13 Costs More Than Chapter 7

Chapter 13 cases take longer and are more complicated. That makes them more expensive. You’ll need to hire a lawyer to file Chapter 13. The success rate isn’t high to begin with.

It drops to just 2.3% for people who file without a lawyer. Filing successful Chapter 13 bankruptcy without legal help is nearly impossible. Bankruptcy lawyers who handle Chapter 13 cases charge significant fees. These cases are long and complex.

Many bankruptcy attorneys charge at least $3,200 for Chapter 13. Compare that to $1,500 for Chapter 7. The cost difference matters when you’re already struggling financially.

The “No Money Down” Myth

One popular reason for choosing Chapter 13: you can file with no money down. Unlike Chapter 7, attorney fees can be extended over five years. Many law firms allow debtors to file with no upfront payment.

That might sound appealing if you’re cash strapped. But it rarely works out well. A recent national study shows concerning results. “No money down” filers actually pay $2,000 more. Their cases get dismissed at a rate 18 times higher.

They don’t get relief from the debt that prompted bankruptcy filing. Attorneys still offer this option because success is possible. Even if you fail, attorneys make money from fees paid before dismissal.

Chapter 13 May Worsen Your Financial Position

Most Chapter 13 bankruptcy cases don’t succeed. If your case gets dismissed, problems multiply. You could end up worse off than when you started. During the repayment plan, interest on unpaid debts keeps accumulating.

Once the case is dismissed, bankruptcy protection ends. You could owe even more thanks to accumulated interest. You’ll have already paid significant costs. Attorney fees, filing fees, and other expenses add up. You won’t get the main benefit: a fresh start.

The bankruptcy still appears on your credit report for seven years. Your credit score takes a hit. Taking out new credit becomes harder.

Chapter 13 Doesn’t Usually Teach Budgeting

Another argument favoring Chapter 13: it teaches budgeting skills. Some attorneys claim Chapter 7 happens too quickly. They say people return to bad habits immediately.

Chapter 13 supposedly shows people how to live within a budget. That’s true for the 33% who complete their plans. But most debtors don’t complete their 3-5 year plan. Failed cases produce no lasting debt relief. Most likely no lasting budgeting improvement either.

Racial Disparities in Chapter 13 Outcomes

One alarming trend: Chapter 13 isn’t applied evenly. Data shows significant racial disparities. Black debtors are more than twice as likely to choose Chapter 13. This holds true even with similar finances to white debtors.

Once Black debtors choose Chapter 13, dismissal rates increase. Their odds of case dismissal are roughly 50% higher. They receive no relief from their debts.

You May Still Lose Your Property

Many people file Chapter 13 to keep assets. Homes and cars are common reasons. Chapter 13 is often called the “keep your stuff” chapter. The reality differs from the promise.

Roughly two-thirds of Chapter 13 cases fail. Most of the time, Chapter 13 doesn’t help you keep property. Desperate filers spend years trying to save assets. Some file multiple bankruptcy cases attempting to prevent repossession.

One Memphis resident filed Chapter 13 four times in seven years. She was trying to hold onto her car. First, she lost her job and fell behind on payments. Her case was dismissed. She filed again immediately to keep the car for interviews.

She used unemployment benefits for payments until they ran out. Second dismissal. She filed a third time. Finally in 2014, after her third dismissal, she got a part-time job. She filed again. Two more years of payments remained. She spent most of her 30s trying to hold onto her car.

“If I’d known,” she said, “I just would have let my car go.” Consider how few Chapter 13 cases result in discharge. How much are you willing to pay for a slim chance?

Chapter 13 May Not Restore Your Driver’s License

A popular use of Chapter 13: recovering a suspended driver’s license. Cities and states suspend licenses for unpaid parking or traffic tickets. Unpaid tickets can’t be discharged in Chapter 7. They can be discharged in Chapter 13.

Many debtors file Chapter 13 to get licenses back. Parking and traffic tickets cause many bankruptcies in Chicago. The bankruptcy court there leads the country in Chapter 13 filings. ProPublica’s research showed troubling results.

Less than 25% of Chapter 13 cases involving ticket debt ended successfully. Most debtors paid thousands in legal fees before dismissal. Not a dime went toward paying traffic tickets. Once cases are dismissed, debtors risk losing licenses again. A cycle of more debt and more bankruptcies begins.

Chapter 7 Usually Works Better

Chapter 13 can be valuable in some cases. But in most cases, it’s an expensive mistake. It produces no lasting debt relief. When possible, Chapter 7 is a much better solution. Even if you must give up expensive assets.

You may love your home, apartment, or vehicle. But you might be financially better off letting them go. Eliminating debt attached to them helps. You’ll also eliminate unsecured debt like credit cards and medical bills.

“It’s not rocket science, I can tell you that,” says Brad George. He’s a Memphis bankruptcy attorney with over 20 years of experience. If there’s an important reason to file Chapter 13, he will. Foreclosure or driver’s license issues qualify. Otherwise, he recommends differently.

“I think you should try and always, always, always do a Chapter 7.” Speak with a bankruptcy attorney for free to understand which option works best for you.