When a debtor is filing for bankruptcy, often their first question is “what happens to my home?” Under a Chapter 13 bankruptcy, a debtor is granted safe harbor for their assets. The purpose of Chapter 13 is to repay at least a portion of the debts the debtor actually owes. How is this determined? A number of factors go into a debtor’s Chapter 13 plan. In this blog, we will discuss the purpose of the Chapter 13 plan, and the ways in which the debtor has control over their plan payments.
Exemptions in Bankruptcy
Before getting into the weeds on how a chapter 13 plan is calculated, it is important for any prospective debtor to understand what an exemption is, and how it might affect their bankruptcy case. An exemption is an amount, determined by the bankruptcy code, that a debtor may keep in a sale of property. A debtor may choose from either the state or federal exemptions. The exemptions help a debtor choose which type of bankruptcy is best for them. Under Chapter 7, exemptions will protect a debtor’s interest in property. Under a Chapter 13, exemptions, or rather the non-exempt interest, will determine the amount the debtor must actually repay.
For example, let’s say a debtor’s house is worth $300,000. The federal exemption for a principal residence is $27,900. That means, in a theoretical sale, a debtor would be guaranteed $27,900 of the proceeds, assuming there are no liens against the property. The remaining $272,100 is considered “non-exempt equity.” There are, of course, many other factors to take into consideration, including mortgages and other liens. These reduce the amount of non-exempt equity a debtor may have in the property.
Differences Between Chapter 7 and Chapter 13
Chapter 7, also known as a liquidation bankruptcy, has the trustee take a look at the debtor’s assets to determine whether any fall outside of certain exemptions allowed by the bankruptcy code. If the debtor’s property does fall outside of these exemptions, the debtor will be forced to either repay that value, or sell the property and give the proceeds, minus exemptions, to creditors.
A Chapter 13 bankruptcy, however, provides safeguards for property. The debtor uses the exemptions to determine what the minimum amount of money they need to pay back in the bankruptcy. A debtor seeking bankruptcy relief may also be forced to file for chapter 13 if they earn above the median income for their state.
Continuing with the previous example, under a Chapter 7 bankruptcy, a debtor would either need to repay the $272,100 difference immediately. In a Chapter 13 bankruptcy, the debtor would be responsible for paying that over the five-year period.
Means Test and Disposable Income
A Chapter 13 also requires a debtor to determine their disposable income. This is the amount of money left over from a debtor’s regular monthly income, after all regular bills are paid. This includes any of the regular living expenses a debtor may have, including food, rent, mortgage, utilities, and even entertainment. The key for these expenses is they must be “reasonable.” In the eyes of the bankruptcy court, this generally means they must be relatively close to the IRS national standards.
While a debtor does need to show their regular monthly expenses, they must also go through the means test to show what, if they adhered to the IRS standards, their disposable income should look like. A debtor should be as close as possible to the national standards, though of course some discrepancies occur. For instance, the IRS does not account for student loans, or a debtor’s mortgage/rent payment may be higher than the standard. The means test is more of a rule of thumb as to where the debtor should be in terms of disposable income.
Plan Payments
Now this brings us to the final question, how are plan payments determined? Simply, it is the higher number of either (1) the debtor’s non-exempt equity in assets or (2) the debtor’s disposable income. While Chapter 13 bankruptcies do provide safe harbor for a debtor’s assets, the bankruptcy courts still expect the debtor to pay at least the value of their non-exempt equity in assets into the bankruptcy plan. If the debtor’s projected disposable income is higher than their non-exempt equity in assets, the disposable income instead is paid into the plan in monthly installments.
- The Debtor’s Non-Exempt Equity
Let’s continue with the above example. Say the debtor owns a home that is worth $300,000. They have a mortgage against the home for $200,000. This means their equity in the home is worth only $72,100, after the federal exemption is taken. If the debtor is married, that interest is cut in half, to $36,050. Additionally, the debtor may include the cost of a theoretical sale in this calculation. This becomes the floor of the debtor’s repayment plan. This is the least amount of money that the debtor can pay back over the course of the bankruptcy plan, and this number would be divided by 60 months, for a monthly payment of (roughly) $600 per month, not including administrative fees. - The Debtor’s Disposable Income
The next step is the calculation of the debtor’s disposable income. As discussed, the debtor inputs their regular monthly expenses. These expenses, however, must be “reasonable.” While a trustee may be understanding of a higher food expense for a family of four, they may be less understanding of a higher entertainment expense for a single person. The IRS national standards discussed above are usually a good benchmark but can be overcome by a debtor’s actual circumstances. If a debtor’s disposable income at the end of the month is higher than the monthly payment using the non-exempt equity analysis, then a debtor’s disposable income must go towards the plan.
While filing for bankruptcy may be intimidating, having experienced and knowledgeable bankruptcy attorneys can make it exponentially easier. Call an attorney at Scura, Wigfield, Heyer, Stevens & Cammarota today to set up a free consultation.
