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How does a payment plan work under Chapter 13 bankruptcy?

Previously we have written about some of the differences between the two most common forms of personal bankruptcy: Chapter 7 and Chapter 13. One of the more significant of those differences is that while Chapter 7 discharges many debts completely, it may still leave some of the debtor’s more valuable forms of property -- such as a house, or a car -- susceptible to being sold off in a trustee’s sale.

Many people who want to use bankruptcy as a mechanism for debt relief also want to retain such assets. For them, Chapter 13 -- and its central feature, the payment plan -- may be an option.

In a Chapter 13 bankruptcy, the debtor has 14 days after filing the petition to submit a payment plan for approval by the bankruptcy court (although this period may be extended if the court grants an extension of time).

Under the plan, instead of making payments directly to creditors, the debtor makes payments to the bankruptcy trustee, who then allocates the available funds among the creditors based on their priority status. Even if the plan has not yet been approved, the debtor must start making plan payments to the trustee no later than 30 days after filing the petition.

Creditor claims will fall into one of three classes of priority:

  • Priority claims, including those having to do with tax obligations or court costs in connection with the bankruptcy (these must usually be paid in full);
  • Secured claims, in which the creditor has a secured or collateral interest in the property subject to the debt (for example, mortgages and car loans); and
  • Unsecured claims.

Secured claims must ordinarily be paid an amount at least equal in value to the collateral that secures the debt. Home loans may continue to be paid according to the time schedule of the mortgage, which may last for a longer period of time than that of the payment plan, but the debtor must still bring any payment arrearages current.

Unsecured creditor claims frequently will not be paid in full, although they must receive from the plan payments at least the same amount that they would have received had the debtor undergone liquidation under Chapter 7.

This post provides only an overview of how a payment plan works. Specific questions about Chapter 13 bankruptcy in general, and payment plans in particular, should be addressed to a qualified legal professional.

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