Why is Chapter 13 Bankruptcy a Bad Idea?
Bankruptcy laws exist for those whose debt has become unmanageable. Whether it’s bad fortune or financial irresponsibility, filing bankruptcy does provide the opportunity to alleviate the debt.
In the United States system, the two most common types of bankruptcy are Chapter 7 and Chapter 13. In Chapter 7 bankruptcy debtors can erase debts with an agreed-on lump-sum payment, but to do so they must liquidate assets that are not exempt. In Chapter 13 bankruptcy, a debtor is allowed to keep their assets, but must agree to a three-to-five year plan to repay debts, then stick to the plan religiously.
Which is a better choice? Off the bat it is easy to say Chapter 13 because it allows a debtor to keep their assets, including their home, provided that they can pay the mortgage as well as bankruptcy payments.
Unfortunately Chapter 7 is the safest option out of the two. There are dangers associated with Chapter 13 bankruptcy that a debtor should be made aware of. A ProPublica study in 2017 even found that those filing Chapter 7 were far more successful in resolving their cases. From 2008-2015, 96% of Chapter 7 filings received a discharge of debt. Only 41% saw a discharge filing Chapter 13.
The pros and cons of Chapter 13 mean it’s not always the best option, and for some it’s simply a bad idea. Here are some downsides of Chapter 13 bankruptcy, that a debtor should be aware of:
- Far higher failure rate than Chapter 7
- High fees and costs
- It can affect a debtors finances
- It impacts African-Americans more severely
- If the bankruptcy fails, a debtor can lose their home and assets
- Lower chance of success
- Because of failure, it does not help budgeting skills
1. Chapter 13 Failure Rate
Most bankruptcy filers in Chapter 13 work out a five-year payment plan, as opposed to a three-year payment plan. In five years a lot can happen. Take for example the pandemic caused by COVID-19. As 2019 ended, very few of us expected that COVID-19 would derail the economy in 2020. Imagine filing for Chapter 13 bankruptcy, then being among the 30 million who lost a job in 2020?
Another thing to consider is that even if a debtor makes it to the end of the five-year timeframe does not mean all debts have been forgiven. Qualifying debt is erased, but things like child support and student loans are not erased.
2. Chapter 13: High Fees & Costs
The main cost for filing Chapter 13 is hiring an attorney. Any individual can file for bankruptcy on his/her or own, but filing Chapter 13 without an attorney is a bad idea. The attorney is an added bankruptcy cost, but not hiring one could cost more in the long run.
The average cost for a bankruptcy lawyer in Chapter 13 is about $3,000-to-$4,000, and could be more depending on the complexity of the case. This payment does not have to be paid as a lump sum, but usually can be paid over time.
The U.S. Bankruptcy Court for the Central District of California tracks bankruptcy statistics, and reports that in 2017 and 2018 69% of those who filed Chapter 13 with an attorney had a successful outcome, but less than 3% of those who filed without one were successful.
3. Chapter 13 Bankruptcy is Bad For Your Finances
The 2017 and 2018 numbers show that almost one in every three Chapter 13 filings resulted in dismissal, which is not the result a debtor is seeking. Dismissal means creditors can again proceed to pursue debt, garnish income or foreclose on property. Money a debtor had paid into the payment plan is applied to interest on debts, which means a debtor will owe more than when they started.
In addition, the protection that bankruptcy provided is lost. Now the debtor has already paid filing and court fees and owes money to the attorney, and their credit score has taken a hit for the next seven years. It all happened without gaining a single benefit that the fresh start bankruptcy is supposed to provide.
4. Chapter 13: 50% Worse for Black Debtors
Another ProPublica study in 2017 showed that the chances are more than twice as high that black debtors will choose the more expensive and complex Chapter 13 filing when compared to white debtors with a similar financial situation. Once the filings are completed, the chances of a case being dismissed are twice as high for blacks as for whites.
The cause for these numbers can be debated, but they do speak loudly.
5. You Don’t Get to Keep Assets If You Fail
With a fairly high number of unsuccessful cases, it should be kept in mind that if a case fails or is dismissed protection for a debtor’s assets disappears.
6. No Money Down, But Less Chance of Success
Because Chapter 13 attorney’s fees can be paid over time, it’s sometimes referred to as “no money down.” But, the money is still due. No money down and extended payments is a great idea if you are in good financial shape, but if someone is in debt and is considering bankruptcy, they are most likely not in good financial shape. A debtor should be aware that they are adding more debt in extended attorney’s fees when they file Chapter 13.
Chapter 7 is simpler than Chapter 13, and if a bankruptcy case is relatively easy to grasp, it’s almost always better to file Chapter 7 – even though attorney fees have to be paid up front. A 2017 study showed “no money down” filers paid $2,000 more in attorney fees and had cases dismissed 18 times more often than if they had simply filed Chapter 7.
7. Low Chances of Chapter 13 Success Offers No Improvement to Budgeting Skills
IThe court-ordered payment will not change for the agreed on time frame, which is usually five years. A filer must be diligent about payments and responsible about having bankruptcy discharged. The 30% or so of filers who are not responsible about ensuring they address what brought them to bankruptcy show they have not learned.
Those who fail to complete the payment requirements see no lasting debt relief, which makes developing a budget and sticking to it, next to impossible.
Alternatives for Chapter 13 Bankruptcy
Bankruptcy should be a last resort. Here are alternatives to consider:
Chapter 7 Bankruptcy
Filing Chapter 7 bankruptcy should always be a consideration before filing Chapter 13. It’s typically simpler and easier, and it results in a successful discharge far more often. Also, it’s faster. The average Chapter 7 bankruptcy typically lasts three or four months, from filing to discharge.
Consolidation focuses on hefty credit card debt. Debt consolidation combines different loans into one, at a lower interest rate. Instead of making several payments at hefty credit card interest rates, one payment is made to one source, at a lower interest rate.
In this agreement where your creditor accepts less than the amount owed. This is a viable option to bankruptcy because lenders will be willing to settle a debt because they prefer getting something to nothing, which may happen in bankruptcy.
CuraDebt Can Help You
If you would like to avoid bankruptcy and are considering debt settlement, please reach out to us today. CuraDebt is a debt settlement company that can help you with all of your debt related needs. Contact us today for your free consultation. 1-877-850-3328