What Happens to Unsecured Debt in Chapter 13 Bankruptcy?

Here's how your unsecured debt, like credit cards and medical debt, is treated in Chapter 13 bankruptcy.

Most Chapter 13 filers don’t pay much toward unsecured debt, such as credit card balances, medical bills, cellphone bills, utility balances, and personal loans. If, however, the unsecured debt falls into the priority debt category, like recent tax balances and domestic support obligations, you’ll pay the entire amount in full.

Read on to learn about the differences between secured, unsecured, and priority debt, which unsecured debts you’ll pay in full, and how to calculate the amount of general unsecured debt you’ll pay through your plan.

Find out more about Chapter 13 Bankruptcy.

Secured and Unsecured Debt in Chapter 13

When you’re filling out your bankruptcy paperwork, you’ll want to know how to divide your debts into unsecured and secured categories. The quick rule is that a secured creditor can take the property you bought if you don’t pay the bill. An unsecured creditor cannot.

For instance, most buyers give a home lender a lien on the financed home. The lien gives the lender an interest in the home or “collateral.” Because the lender can sell the property if the borrower fails to pay the mortgage, the mortgage is a secured debt.

By contrast, most credit card debt is unsecured debt. A credit card lender can’t take back the school clothes or pet supplies charged with the card if the borrower fails to make the monthly payment. Child support arrearages and unpaid gym membership fees are also unsecured debts.

Learn more about secured and unsecured in bankruptcy.

Priority and General Unsecured Debt in Chapter 13

Separating secured from unsecured debt is just the first step. Next, you’ll want to divide your unsecured debts into two categories: priority unsecured debt and general unsecured debt.

Priority Unsecured Debt

Priority debts get special treatment in bankruptcy—it moves to the head of the payment line. The most common priority claims in Chapter 13 cases are:

  • Domestic support obligations. Child and spousal support obligations owed as of the filing date are entitled to top payment priority.
  • Administrative expenses. Administrative expenses are claims incurred in connection with a bankruptcy case and are second in line for payment. The primary administrative expenses in most Chapter 13 cases are fees owed to debtor’s counsel and the Chapter 13 trustee.
  • Taxes. Delinquent state, federal, and property taxes, subject to specified time limits, also have priority over general unsecured claims. Learn more about taxes in Chapter 13 bankruptcy.

General Unsecured Debt

Examples of nonpriority, unsecured claims include ordinary credit card debt, medical bills, back rent, student loans, utility bills, loans that do not require collateral, health club dues, union dues, and some tax debts.

Paying Priority and General Unsecured Debt

Here’s how you’ll divide the funds:

  • Your priority unsecured creditors get paid first and must be paid in full. If you don’t have enough funds to pay your priority creditors, the court won’t confirm (approve) your plan.
  • Any amount that remains after paying your priority unsecured creditors will go to your general unsecured creditors.

General unsecured creditors get paid on a pro rata basis. They’ll all receive the same percentage of the balance owed.

However, as long as you act in good faith, you may selectively pay nonpriority claims, in effect favoring some creditors over others. For instance, criminal fines are nondischargeable. It can still be enforced through collection remedies after the bankruptcy case is closed. Chapter 13 plans, on occasion, provide for payment of nondischargeable obligations, such as criminal fines, before other unsecured debt.

Find out the differences between priority and nonpriority debt in bankruptcy.

Calculating Chapter 13 Repayment Plan Payments

It isn’t easy to determine how much you’ll pay in your Chapter 13 repayment plan. In fact, most attorneys use specialized software. Below you’ll find an overview of the process.

The Amount You Must Pay For All Unsecured Debt

First, you’ll calculate how much you’ll be required to pay toward all of your unsecured debt—priority and general secured alike. The amount will depend on:

  • whether you qualify for a Chapter 7 discharge
  • the amount your unsecured creditors would have received had you filed for Chapter 7 bankruptcy (the “bests interests of creditors” test), and
  • how much “disposable income” you’d have after paying allowed obligations.

Here’s how the calculations work.

Chapter 7 Qualifications

Most Chapter 13 filers do so because they couldn’t qualify for Chapter 7 bankruptcy. But that’s not always the case. Some people choose to file for Chapter 13 because it offers benefits not available in Chapter 7. For instance, only Chapter 13 allows filers to catch up on home arrearages and keep a house, or pay off nondischargeable debt such as domestic support arrearages over three to five years.

People who qualify for Chapter 7 are only required to file a three-year repayment plan, and they don’t need to worry about paying all of their disposable income into the plan. These debtors can choose to pay up to five years and many do because a lower monthly payment can help with plan confirmation.

All Debtors Must Comply With the Best Interests of Creditors Test

The "best interests of creditors" test requires all Chapter 13 debtors to pay unsecured creditors at least as much as they would receive in a Chapter 7 liquidation. So how do you figure out how much that would be? It isn’t as hard as it might sound.

First, you’d assess whether you can protect all of your property with bankruptcy exemptions. Next, you’d determine the value of any property you couldn’t protect, minus sales costs. The final amount is what you’d use for the best interests of creditors test.

Here’s why it works that way.

In Chapter 7, the trustee sells the filer’s nonexempt property and distributes the proceeds to unsecured creditors. A Chapter 13 trustee doesn’t sell the filer’s property, however. Instead, filer keeps all assets. But that doesn’t mean a Chapter 13 filer gets a better deal. At a minimum, all Chapter 13 filers must pay unsecured creditors an amount equal to the filer’s nonexempt property—the same amount that would get sold in a Chapter 7 case.

Most Debtors Must Pay All Disposable Income Into the Plan

The next calculation is the disposable income calculation. Disposable income is the difference between a debtor’s total earnings and the amount reasonably necessary to pay for the debtor’s family’s maintenance and support. Be aware that it isn’t based on your actual budget. You’ll have to use local and national standards for some expenses.

Whether you must commit your disposable income into your repayment plan depends on whether you passed the Chapter 7 means test. Debtors who earn more than their state’s median family income—in other words, debtors who make too much to qualify for a Chapter 7 discharge—must pay all disposable income to unsecured creditors for five years.

Debtors who earn less than the median family income in their home state—in other words, they could pass the Chapter 7 means test but are choosing to file for Chapter 13—do not have to pay all disposable income into the plan.

Who Must Pay What Amount to Unsecured Creditors?

What you’ll actually pay will depend on two factors: the bankruptcy chapter you qualify for and whether you can exempt all of your property.

  • Filer qualifies for Chapter 7 but doesn’t own nonexempt property. This Chapter 13 filer doesn’t have to worry about the disposable income or best interest rule. The filer is free to use the special mechanisms available in Chapter 13, such as catching up on home or vehicle arrearages or paying off nondischargeable debt, without paying anything to general unsecured creditors. (Check your jurisdiction to be sure your court will allow what’s commonly known as a zero-percent plan.)
  • Filer qualifies for Chapter 7 and owns nonexempt property. This Chapter 13 filer must comply with the best interest rule, but not the disposable income rule. The filer must pay unsecured creditors an amount equal to the filer’s nonexempt property.
  • Filer doesn’t qualify for Chapter 7 but doesn’t own nonexempt property. This filer must comply with the disposable income rule. The best interest rule won’t apply.
  • Filer doesn’t qualify for Chapter 7 but owns nonexempt property. This filer will pay the greater of the filer’s disposable income or the value of the filer’s nonexempt property.

Learn more about bankruptcy exemptions.

You Might Have to Pay Even More in Chapter 13

Now that you know the minimum amount that you’re required to pay, keep in mind that you must pay priority debts in full. It doesn’t matter if your disposable income and best interest test calculations suggest you’re required to pay less than the amount of your priority debt, the judge won’t confirm your repayment plan unless you establish that you can—and will—pay all priority debt in full.

The Repayment Plan Process

You’ll start making your repayment plan payment shortly after filing your case—even though your plan won’t be confirmed. You’ll make the plan payment to the Chapter 13 trustee. The trustee will deduct a fee from each monthly payment (up to 10%) and distribute the balance to creditors in accordance with the plan.

Most Chapter 13 plans authorize distributions to general unsecured creditors only after priority and secured claims are paid in full. So even if payments to unsecured creditors can be made, they aren’t funded or distributed until late in the plan period—about three to five years after you file bankruptcy. (This is why receiving a Chapter 13 hardship discharge is somewhat unusual.)

Learn about the types of debt you can discharge in Chapter 13.

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