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Differences Between Chapter 7 Bankruptcy and Chapter 13 Bankruptcy

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The primary difference between a Chapter 7 bankruptcy and a Chapter 13 bankruptcy is that a Chapter 7 bankruptcy can eliminate debt in a period of three to four months compared to the three to five years it takes to complete a Chapter 13 plan. Under certain circumstances, a Chapter 13 bankruptcy can be converted into a Chapter 7 bankruptcy.

We recently discussed several aspects of bankruptcy with Christopher Holmes and Jess M. Smith, III, partners at Tom Scott & Associates, P.C. The discussion covered several topics, including the means test, the differences between Chapter 7 and Chapter 13, how divorce and child support can affect bankruptcy, and the discharge process. Below is Part 2 of 4 of the transcript of that conversation.

Q: For a debtor, in terms of moving forward with your life after you declare bankruptcy, what are the differences between between Chapter 7 versus Chapter 13? How does that affect your credit score or your standing in the financial world?

Jess Smith, III: In the short-term, a Chapter 7 is probably more advantageous, because when you’re in a Chapter 13 there’s always the risk that you won’t complete the plan and you’ll become eligible to convert it to a Chapter 7. Therefore, you can add debt to your bankruptcy that accrue from the time you file your Chapter 13 to when you convert to your Chapter 7. That makes lenders nervous about extending credit to you while the Chapter 13 is open, because they could take a hit.

Chris Holmes: I always tell people you’re in a case for three to four months under Chapter 7. Your done and you can do whatever you want. In a Chapter 13, you can’t borrow money without permission of the trustee or the judge. As Jess pointed out, debts that are incurred after the filing of the case, if they change their mind and switch to a Chapter 7, they can be thrown into the mix for discharge.

Q: So what would be the circumstance in which someone could switch from a Chapter 13 to a Chapter 7?

JS: A loss of income is the primary one.

CH: People start out and maybe they’re too rich. they make $100,000 a year and can pay back some of the debt. Then their job goes overseas and they’re making $10 an hour; income plummets; no money left over for the creditors; case is no longer feasible. And so we switch to a Chapter 7, dispense with the monthly payments, and just wipe out the rest of the debt.

JS: Another reason someone might want to start as a Chapter 13 and contemplate having the option of a Chapter 7 later is that you have people with substantial medical issues. Perhaps they have a few creditors coming after them now, where they need that protection. But they don’t want to file Chapter 7 now, because they know they’ve got medical issues within the next eight years that are going to crop up. Some of them will go into a Chapter 13, to establish a payment plan with those existing creditors, knowing that if a medical calamity happens before the Chapter 13 is done they can convert to a Chapter 7 and add those debts.

CH: It’s kind of a way to insure against uninsured events over this three- to five-year period, so if something terrible happens—they run up $50,000 of uninsured medical debt and they can’t afford to pay it—the law says we can switch from a Chapter 13 to a Chapter 7 and move those debts. Generally speaking, when you file the case, you’re going to list the debts prior to that date. In a Chapter 13 or a 7, you can’t add debts thereafter. Unless you switch it from a Chapter 13 to a Chapter 7, so that deadline before which debts can be added moves up to the date of conversion to a Chapter 7. So, all of those debts incurred in-between, that otherwise a debtor would have been stuck with, are added to the list.

Q: It seems as if wiping out debts completely under Chapter 7 is a more drastic financial transaction. Does that affect your credit score more negatively than filing a Chapter 13?

CH: You would think that someone filing under Chapter 13 who is paying back some of the debt would get some kind of credit for that. But my understanding is that a bankruptcy is a bankruptcy is a bankruptcy to most creditors, whether it’s a Chapter 13 or a Chapter 7. People don’t get credit, in a sense, for paying back some of their debt through a Chapter 13 plan.

JS: Not until the Chapter 13 discharge, but while you’re in it you get no positive benefit from it.

CH: No one is going to pat you on the back and say, “You’re paying back some of your debt, here I’ll give you more money.”

JS: At the end, if it shows you paid your mortgage on time and you paid your car off in full, you’ll get credit for those things. But your not going to get a boost for running into a Chapter 13 as opposed to a Chapter 7. Not in the short-term, no.

Q: But in the long-term?

JS: Potentially, yes.

CH: I tell people that supposedly debts stay on your credit reports seven to 10 years.

JS: Usually from petition date.

CH: So being in a Chapter 13 for three to five years, as opposed to a Chapter 7 for three to four months, won’t stay on your record any longer.

JS: A Chapter 13 will actually come off the credit report sooner. A Chapter 7 will be up there for up to 10 years; a Chapter 13 for about seven years.

Q: So an advantage to completing a Chapter 13, in the long-term, is that it will help you establish better credit sooner?

JS: Potentially. But in the short-term it’s the same.

CH: People always ask, “What’s a bankruptcy going to do to my credit rating?” Well, if you’ve got $50,000 of credit card debt, $30,000 of medical bills, and people are suing and garnishing and hounding you, your credit worthiness is already shot. In a weird sort of way, when you get a discharge in bankruptcy, you wipe that slate clean. You can’t file another bankruptcy for eight years, but if you have decent income and no debt, I would imagine that one’s credit worthiness is going to be enhanced by wiping the slate clean. We have debtors who tell us that just weeks later they start getting inundated with car loan applications, even though they’re in a bankruptcy. I assume that’s because the creditors are sophisticated enough to know they can’t file another bankruptcy and they can’t add any post-filing debt to the bankruptcy. So, any car loan after the filing can’t be added; they can’t file another Chapter 7 for eight years, and they’ve got decent income and they know all of this debt is going to be wiped out, a new loan can’t be discharged. I assume that’s why they are aggressively marketing to those people.

Q: So, you can’t file another Chapter 7 for eight years after having filed a Chapter 7?

CH: Date of filing plus eight years.

Q: How about if you file for Chapter 13, then complete that 60-month plan and the bankruptcy is discharged?

JS: If you file a Chapter 13 first and complete it, you can file a Chapter 7 six years after your Chapter 13 filing date, under certain circumstances. If you file a Chapter 7 first and then you file a Chapter 13, it has to be four years after your Chapter 7 filing to be eligible for a discharge. We have people who file them so close together they’re not eligible for any discharges. They complete an umbrella, so they can get their things sorted out. With an umbrella, the creditors are told to stay, while the debtor makes some sort of a payment plan. We have people complete those payment plans and then they still have to deal with the debt, because it wasn’t discharged. But, in the interim, that period of the five-year window, they’re able to live their lives and try to get their affairs in order.

CH: Or we put them in one of these bankruptcies just long enough until finally it’s been long enough to file a bankruptcy from which they can get a discharge. So, we let the case be dismissed and then re-file when it’s been long enough.

JS: I just placed someone into a Chapter 13 where basically the primary purpose was that her main debt was student loans. She made about $70,000 salary and, based on her household size, she could file a Chapter 7. But the student loan creditor said, “You owe us over $100,000, so we’re going to administratively garnish 15% of your wages. And she said, “No you’re not. I’m going to file a Chapter 13 and I’m going to pay you $500 a month for the next five years, so I can get my kids out of the house.” Otherwise she knew that 15% was going to have her end up being evicted, because it was too much of her income.

CH: Another reason we do Chapter 13 filings is because student loans are nondischargeable. If, for example, the debtor has other problems and the student loans is just too burdensome, we put them in a Chapter 13, so they can keep the student loan creditor at bay for five years. Meanwhile they can resolve some other cash issues or save their house or do whatever they need to do. But then, of course, because it’s nondischargeable, down the road that student loan is still there. Chances are that what was paid to the student loan through the five year plan won’t cover the interest that accumulates, so that student loan is probably going to be bigger. But at least they can get rid of all their other financial problems and then they can focus on the student loan at the end of five years. Hopefully at that time the money that was in the plan to solve other problems will be there to solve the student loan five years down the road.

JS: We refer to that as a Chapter 26. That’s when you get through your first Chapter 13 and shed everything but the student loan, and then if you’ve got all of the kids out of the house, maybe you’re in another Chapter 13 where your student loan is your only creditor and you try to knock it out during the second five-year plan.

Q: So, regardless of whether you file Chapter 7 or Chapter 13, student loans are not dischargeable?

JS: Correct. By and large, with rare exceptions.

Q: And that’s the same for federal taxes?

CH: Well, no. Taxes are a little different, although that gets complicated, too. But, generally speaking, if the taxes are less than three years old, you’ve got to pay them back. Taxes more than three years old may be dischargeable, but then you have to worry about whether there is a federal tax lien. Some of the tax might have to be paid back. I’m about to file a case for a debtor who had some taxes owed for 2012. The clock didn’t start ticking until April 15, 2013, because taxes are always due by April 15 the following year. So, I said to her, “Look, you’ve got all of these taxes owed for 2012; we don’t have to file your bankruptcy sooner than later. Let’s wait until after April 15, 2016, so they’ll be more than three years old and then maybe those 2012 taxes will be treated just like a credit card or medical bill, and be totally wiped out.” The threat was that in the interim, unbeknownst to me, the IRS filed a tax lien, which would make some of the tax payable. The hope is that the tax is going to fall off as a dischargeable debt.

Part 1 of Conversation: Means Test Helps Determine Filing For Chapter 7 or Chapter 13 Bankruptcy

Part 3 of Conversation: Divorce and Child Support Can Impact a Bankruptcy

Part 4 of Conversation: Being Discharged From Bankruptcy

Being Discharged From Bankruptcy

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When a Chapter 13 bankruptcy plan has been completed by a debtor, a few steps remain before the bankruptcy is officially discharged. The discharge process includes the filing of the Notice of Plan Completion by the trustee, along with the filing of two forms by the debtor: the Debtor’s Certification of Eligibility for Chapter 12/13 Discharge and the Motion for Entry of Chapter 12/13 Discharge. If the debtor has a mortgage, additional forms are required.

We recently discussed several aspects of bankruptcy with Christopher Holmes and Jess M. Smith, III, partners at Tom Scott & Associates, P.C. The discussion covered several topics, including the means test, the differences between Chapter 7 and Chapter 13, how divorce and child support can affect bankruptcy, and the discharge process. Below is Part 4 of 4 of the transcript of that conversation.

Q: If you’ve filed Chapter 13 and you’ve made all of your payments on-time to the trustee over the course of the three- or five-year plan, what is the next step for the debtor to ensure that everything is legal and the bankruptcy is discharged?

Jess Smith, III: The trustee files a Notice of Plan Completion. Copies of this notice are e-mailed to anyone who receives electronic notification in the case. The debtor then signs a motion for discharge (Motion for Entry of Chapter 12/13 Discharge) and a document stating they’re eligible (Debtor’s Certification of Eligibility for Chapter 12/13 Discharge).

Q: Does the debtor need to go back to their lawyer?

Chris Holmes: Yes. Our paralegal, Margaret, takes care of all of that. She prepares these documents; the debtor comes in and signs them; and we file it. Generally, the debtor receives an order granting discharge.

JS: Typically, the trustee has received all of the money from the debtor and dispersed it out to the creditors. There is one other thing that they sometimes do. If there is real estate involved and the trustee had made any distribution to the creditors whatsoever, the trustee files what’s called the Notice of Final Cure Payment, to which the mortgage companies have a duty to respond, to state they think that the debtor is current on the mortgage or not current on the mortgage. It’s kind of a final chance for the mortgage company to speak up before a Chapter 13 discharge.

CH: We used to have these problems where we’d have people in Chapter 13s and we thought they’d paid all of their mortgage payments and were caught up on what they were behind. They’d get their discharge and then they’d get a notice from the mortgage company stating, for example, they were still two months behind, which would cause all sorts of problems. So the courts came up with this procedure to have the trustees state their belief that the mortgage is current, which shifts the burden to the creditor to come into bankruptcy court and prove otherwise.

JS: Or, the mortgage company would tack on fees, hide the ball, and not tell anybody until discharge. All of sudden they would say, “Well, we charged you $3000 to monitor your bankruptcy. You owe us next week or we’re going to foreclose.”

Q: That’s in the past?

JS: That’s in the past.

Q: So if a debtor has completed the 60-month plan; they’ve paid the trustee on-time each month; they’ve paid their mortgage on-time each month; the trustee will send a notice to the mortgage company?

JS: Yes. And to the debtor.

Q: The debtor takes that notice and brings it back to their lawyer?

CH: We get a copy, so we know at the same time.

Q: So when you receive a copy of the notice sent to the debtor that states they’re eligible for discharge, a paralegal in a bankruptcy law office will do what with that notice?

JS: There are two different documents. The first is the Notice of Plan Completion, which deals with the payments and disbursements to creditors. The second document is the Notice of Final Cure Payment, which strictly relates to the mortgage lenders. When the trustee sends the Notice of Plan Completion, the debtor has to move for discharge. When the trustee sends the Notice of Final Cure Payment, there’s a burden on a mortgage company to file a response, usually within 30 days, stating whether the mortgage is current or not. If a mortgage company doesn’t file one, usually the trustee sets a hearing.

CH: First of all, the debtor gets a discharge, so the rest of the debt that wasn’t paid is wiped out—rendered null and void. And if there’s not a controversy about whether the mortgage is current, there’s an order stating it’s current. That gives the debtor a fresh start, so that the next month they don’t have to worry about the mortgage creditor saying, "Wait a minute. You still owe us $500." When the order is issued, the mortgage company can’t foreclose.

Q: So, if there’s no mortgage, the law office receives a copy of the Notice of Plan Completion. At that point, the law office automatically…

CH: …generates a document to be signed by the debtor that we then file to get them the discharge.

Q: And if there is a mortgage, do you wait 30 days to see if you’ve received back anything from the mortgage company?

JS: Let me give you an example. Normally the mortgage company will say, “We agree the trustee has paid everything that was owed pre-petition,” and either, “We agree they are current,” as of the date they file the response or they say, “No, we disagree and they owe four months of payments,” as an example.

Q: And if the mortgage company ignores the Notice of Final Cure Payment?

JS: If they ignore it, the trustee sets a hearing.

Q: Normally, if the mortgage is current, will the mortgage company respond back as soon as they receive the notice?

JS: Right, But let’s say they either blow it off or they say the debtor is delinquent. If they blow it off, the trustee is going to set a hearing to get an order from the judge.

Q: Does the debtor have to go to the hearing or just the mortgage company?

JS: Typically, you want the debtor there. Here’s an example: In this particular case, the trustee said, “We’ve paid everything we should pay and we think the debtor is current.” But the mortgage company said, “Well, we agree that you paid what was owed prior to filing, but we did an escrow analysis eight months ago, and didn’t tell anybody, and the debtor’s escrow is now short by $700.” So the trustee said there needs to be a hearing on the matter, because it’s not his fault. The trustee was caught in a position of wondering if he needed to go extract money from Visa and MasterCard to pay it on the mortgage, because the mortgage company messed up. We had a couple of hearings on this matter and the mortgage company backed off of its position, stating we’re not going to get the money through the plan. But the judge said that if that mortgage company truly advanced the money, it’s entitled to reimbursement, so you need to work out an agreement. So, we worked out an agreement that states the debtor has six months after the bankruptcy is done to cure the escrow shortage by paying one-sixth of the delinquent amount directly to the mortgage company. As long as the debtor does that, the mortgage company can’t foreclose.

CH: The mortgage creditor has an affirmative duty to tell the trustee how much the regular monthly mortgage payment is to be paid through the plan, so the trustee knows how much to send. Evidently in this case, the mortgage company neglected to say that it needed to increase the payment to make up for that shortfall. The mortgage payment has principal and interest, plus it escrows every month for one-twelfth of the annual taxes and insurance premium.

JS: This was a mess where, after the trustee had made the payments every month for five years, when the case was getting ready to close, the mortgage company sent a letter to the debtor stating, “You need to start making these payments and here is the account number, per the proof of claim.” So the debtor started sending the payments, but they weren’t getting cashed. We finally got to the bottom of it: the account number had changed but the mortgage company did not tell that to anyone. There was a lot of incompetence by this mortgage company.

Part 1 of Conversation: Means Test Helps Determine Filing For Chapter 7 or Chapter 13 Bankruptcy

Part 2 of Conversation: Differences Between Chapter 7 Bankruptcy and Chapter 13 Bankruptcy

Part 3 of Conversation: Divorce and Child Support Can Impact a Bankruptcy

Accruing Post-Petition Interest on Unpaid Federal Taxes (Interview Part 3 of 3)

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Penalties for unpaid federal taxes are still dischargeable when filing for bankruptcy, but they will accrue post-petition interest that is owed to the IRS. Debt limit amounts have changed for Chapter 13 cases, as of April 1, 2016.

Editor: We recently discussed the changes in the bankruptcy laws with Christopher Holmes, Jess M. Smith, III, partners at Tom Scott & Associates, P.C., along with associate attorney Andrew DeYoung. Below is Part 3 of 3 of the transcript of the conversation.

Q. What else is new in bankruptcy law?

Chris Holmes: Some of our clients have received letters from the IRS. We thought certain taxes or certain penalties or certain interest on taxes were going to go away, upon discharge. But now the IRS is coming after people—after discharge—for non-dischargeable penalties and interest on taxes that were fully paid through the Chapter 13 plan. In the good old days we would tell people that once you’re done with that Chapter 13 plan, you’re done with the IRS; you’re done with the Indiana Department of Revenue; you have no more tax worries. Now we’re finding out that is not always true, depending upon when the tax returns were filed. So, in affect, the IRS is punishing people for not filing their tax returns in a timely fashion. So, if tax returns are not timely filed and they’re filed within two years of the filing of a bankruptcy case, those taxes are not dischargeable nor are the penalties and interest thereon. Previously, you would throw those taxes in the plan, pay them in full, and then the penalties and interest would be discharged.

Jess Smith, III: Now they’re boarding up the penalties, but accruing post-petition interest.

CH: So the penalties are still dischargeable; it’s just the interest that’s still accumulating, and will be there at the end of the road. So, now we get these calls from our clients saying, "Hey, what’s going on? I got this letter from the IRS," and we have to give them the sad news that when the law changed back in 2005, there was a provision in there that allows the IRS to collect these interest charges on debts that were otherwise fully-paid through the plan.

Andrew DeYoung: Starting April 1 of this year, and this only relates to Chapter 13 cases, the debt limits are going up. That means the amount of unsecured debt that you have is increasing about $10,000. Debtor’s going into bankruptcy are able to have another $10,000 owed out and still will qualify for a Chapter 13 case. It’s now $394,725, up from $383,175. For secured debt, the amount is now $1,184,200, up from $1,149,525. It changes every three years and it can be found in the Federal register if you use the code words "109(e)" or "Chapter 13 debt limit." 

CH: It’s pretty rare that someone would have debts of that amount.

AD: One case that we worked on the debtor had purchased some vacant real estate in Florida, when the market was doing very well. He purchased the property for roughly $300,000 to $350,000 per parcel. The value then went down to under $50,000 per parcel. We ran up against the debt limits on that issue. We were luckily able to negotiate with the creditor to work a solution in the Chapter 13, but if the creditor had not agreed to work with us we would not have been eligible for a discharge in Chapter 13 because the secured debt of the debtor was too high. In a case I’m working on now the problem is where the debtor has student loans totaling $370,000. The rest of their unsecured debt is not very high, but with the debt limits only around $390,000, absent an agreement with the Department of Education, we’re not eligible for a Chapter 13.

CH: The consequence would be that they have no choice but to resort to a Chapter 11, which is primarily designed for corporations and individuals with really, really complicated situations — and those cost a whole lot more for attorneys fees and court costs.

AD: In talking to the U.S. trustee, I was advised two days ago that you would be a fool to take a Chapter 11 for under $10,000 (as the attorney fee), which in comparison to our Chapter 13 fee would be a total fee over 60 months of $4000. $10,000 up front in one sum or $4000 over 60 months is quite a big difference.

CH: It’s rare, but once in a while you get a debtor who has that kind of debt, and then you have to really go into how much the really totals out to be. You think it might be a certain amount, but the hope is that it falls under those thresholds so you can just barely make it into a Chapter 13.

Part 1 of Interview: What’s New in Bankruptcy Law in Indiana

Part 2 of Interview: Property You Can Protect When You File for Bankruptcy

Property You Can Protect When You File for Bankruptcy (Interview Part 2 of 3)

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Retirement accounts are exempt from creditors when filing for bankruptcy, but an inherited IRA is not. A recent ruling extending the time to cure arrearage might help you save your house after a tax sale.

Editor: We recently discussed the changes in the bankruptcy laws with Christopher Holmes, Jess M. Smith, III, partners at Tom Scott & Associates, P.C., along with associate attorney Andrew DeYoung. Below is Part 2 of 3 of the transcript of the conversation.

Q: Can you mention some of the things you can protect and some that you cannot protect when filing for bankruptcy?

Chris Holmes: Real estate. If it is your residence, you can protect up to $19,300 of equity. If it’s a joint filing and the property is owned jointly by a husband and wife, they can protect up to $38,600. Sometimes, when only one of them files, the property owned by a husband and wife is totally off limits to the creditors. That comes in handy sometimes.

Q: Based on cases you’ve dealt with, what are examples of the types of property people will include in their bankruptcy filing?

Jess Smith, III: The cash value of life insurance polices.

Andrew DeYoung: 401k accounts. IRA accounts. It can be as general as the clothing on your back. It’s what the exemptions apply to.

CH: But inherited IRAs are not exempt.

JS: It’s complicated and that’s why you should consult with an attorney.

CH: In general, retirement accounts—IRAs, 401Ks, defined benefit pension plans—are exempt, off-limits, no matter how much money is in there. But there was a recent decision where someone inherited a person’s IRA. The person who had the IRA died; someone inherited the IRA. The person who died could have protected that in its entirety from his or her creditors, but when it was inherited by the recipient—the debtor— it wasn’t off-limits to the creditors. It became subject to being taken and liquidated for the benefit of the debtor’s creditors.

Q: Was this decision a case you worked on or a precedent-setting case?

CH: It was a precedent-setting case in the 7th Circuit Court of Appeals in 2013, Clark (debtor) v. Rameker (trustee), in which a decision was made by the judges that an inherited IRA is not exempt in certain circumstances. (ed., The Supreme Court affirmed this decision by unanimous vote in 2014: Funds held in inherited Individual Retirement Accounts are not “retirement funds” within the meaning of 11 U.S.C. §522(b)(3)(c) and therefore not exempt from the bankruptcy estate.)

JS: And there was the case of someone buying a new car on the eve of bankruptcy to protect the lien, or affecting the lien. If the creditor does not affect the lien on the title, sometimes the trustee can take the car itself.

CH: Right. I recently had a case where right before the people came in to sign the paperwork, just two days before, they went out and bought two cars. So I had to change the paperwork and their list of creditors, but then the problem was that we had to know for certain that the creditor had put their lien on the title to each vehicle—and they had to do that within 30 days of whenever the people got the car. Otherwise, in a Chapter 7 bankruptcy, or even in a Chapter 13, the trustee could void the lien, take the car and liquidate it. Unless we did something else to prevent that, we would have to wait 91 days from the transfer of the title to file the bankruptcy. Otherwise, it creates what’s called a “preferential transfer.” With that situation, a trustee could set aside that preferential transfer and try to confiscate and liquidate that car.

There is another recent precedent-setting case that has changed in bankruptcy law. Previously, when a house had been sold by the county treasurer for delinquent taxes, the debtor had one year to redeem the property—pay the taxes plus a rate of interest—to keep the house from going to the tax sale purchaser. In the bad old days, we would have to tell people, "You’ve got to file a Chapter 13 bankruptcy before the tax sale to get the benefit of the three- to five-year Chapter 13 plan, to cure that real estate tax arrearage and save the house. If the tax sale had occurred, we couldn’t use a Chapter 13 plan to give them three to five years to cure that problem. They still had this one-year statutory redemption period, but luckily one of our judges, Judge Carr, ruled that you can now use a Chapter 13 plan after the tax sale has taken place to force everyone to back off for three to five years, to give that debtor ample time to cure that arrearage. So that is a new development we can use to save houses after tax sales.

Part 1 of Interview: What’s New in Bankruptcy Law in Indiana

Part 3 of Interview: Accruing Post-Petition Interest on Unpaid Federal Taxes

What’s New in Bankruptcy Law in Indiana (Interview Part 1 of 3)

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The official bankruptcy forms changed as of December 1, 2015, which will impact pro se debtors filing Voluntary Petitions. Mistakes made by pro se debtors include handling of tax refunds and submission of the document production form. Indiana bankruptcy exemption limitations have also changed.

Editor: We recently discussed the changes in the bankruptcy laws with Christopher Holmes, Jess M. Smith, III, partners at Tom Scott & Associates, P.C., along with associate attorney Andrew DeYoung. Below is Part 1 of 3 of the transcript of the conversation.

Q. What’s new in bankruptcy law in Indiana?

Chris Holmes: First of all the official bankruptcy forms changed as of December 1, 2015, so the forms are much more complicated. I think they require much greater sophistication. It’s probably going to impact the pro se debtor — the people who want to represent themselves in a bankruptcy. The forms are supposed to be simpler, but I believe they are much more complicated and perhaps will drive some people to attorneys to have them filled out properly.

Q: What are the different types of information that those forms are now asking people to include?

CH: The same information is being requested, but in a much more confusing way.

Q: Let’s start with that information. What types of information do the forms require?

Andrew DeYoung: The Voluntary Petition, for example, used to be a three-page document. Now, it’s an eight-page document. They’ve taken the old forms and added more language to read and understand, and it’s increased the size of the paperwork in a petition package to 23 pages per case. (Reference: United States Bankruptcy Court Southern District of Indiana Pro Se Debtor Packet)

Q: What kind of information is included in that Voluntary Petition?

AD: All of the property that a debtor owns; all of the creditors that a debtor owes money to; their income; their place of employment; and money they spend on a monthly basis for their household expenses, so it forces debtors to come up with a budget.

CH: People who think they can do it themselves might be fooling themselves, because the paperwork has become so much more complicated and the law imposes so many more requirements on debtors and their counsel to provide certain information and documents. I saw a story today where a woman was trying to do it herself. She had filed her tax returns, but then she had filed her bankruptcy before she had received and spent her tax refund money. So, the trustee was telling her that he was going to be suing her for his fair share of those refunds, because she had not received and spent them before she filed for bankruptcy. As of the date of filing, the refund was an asset of the bankruptcy estate, and the bankruptcy trustee, on behalf of all of the creditors, is entitled to take his fair share of it and distribute that money amongst the creditors. So, she didn’t know that, because she was doing it herself, and now her case is threatened with dismissal and her debts may never be dischargeable. She’ll be denied a discharge if she doesn’t turn over that money to the trustee.

Q: What other common mistakes do people make when they file for bankruptcy for themselves?

AD: We actually had a client, who retained us at our Shadeland Ave. office last week, whose petition I review at our free consultation. She had done everything correctly, but she paid a petition preparer to get it together, which cost her $300. She showed up at the meeting of creditors, but the trustee sent her home because she did not provide him with the document production form, which is required in Chapter 7 cases. So even though this particular person did everything correctly, it still resulted in the hearing not being held and her coming to retain us to get together her document production and fix the different things in her petition that a trustee may want to see perfected. So, she wound up financially in exactly the same place she would have been, minus $300, if she had just hired us to begin with.

Q: It sounds like cases in which people who file their taxes by themselves receive a letter from the IRS that states they owe thousands of dollar in unpaid taxes, plus interest and penalties, and then they hire an accountant to help them resolve the situation.

CH: Yes. I probably could do my own taxes, but I choose to pay someone to do it for me because it’s complicated and I want it done right. I like to use another analogy. I used to change the oil in my car. It’s doable, but I’d rather pay someone to do it because I want it done right, they can dispose of the oil more efficiently that I can, and I’m also afraid I might not get the lug nut in properly. Who knows what could happen then?

Also in regard to the bankruptcy forms is that the exemptions have changed. Indiana has a statute, Indiana Code 34-55-10-2: Bankruptcy exemptions; limitations, which tells people how much property they can protect from their creditors—or in the bankruptcy context, from the trustee who represents their creditors. Those numbers recently increased. It used to be you could protect $17,600 in equity and real estate; that number has gone up to $19,300. Or people could protect $9350 of tangible personal property; that’s now $10,250. So these are important details. Some people who represent themselves perhaps have valuable property that could be taken by the trustee. Like that tax refund situation, they could protect $400 of the tax refund now, as opposed to only $350 previously. There are some sections in the code that tell you some things that you can protect and some things that you can’t protect that are very critical in determining whether you file a Chapter 7 or Chapter 13 bankruptcy. That’s because something might be lost and liquidated in a Chapter 7, but you can pay your creditors enough money to protect those assets in a Chapter 13 case.

Part 2 of Interview: Property You Can Protect When You File for Bankruptcy

Part 3 of Interview: Accruing Post-Petition Interest on Unpaid Federal Taxes

Bankruptcy Strategy for Client with Chronic Medical Condition and No Health Insurance

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Medical Bills Past Due

A remedy is available for a man without medical insurance who has a serious medical condition that prevents him working. Many people with medical conditions seek debt relief through a Chapter 13 bankruptcy plan, with the option of converting that to a Chapter 7 bankruptcy later, if medical bills become overwhelming while the plan is in effect.

We recently discussed how medical issues and bills impact bankruptcy filings with Christopher Holmes and Jess M. Smith, III, partners at Tom Scott & Associates, P.C. Below is a transcript of that portion of the conversation.

Chris Holmes: I have a current client who lives in the near-north side of Indianapolis. He is in his 40s and has children. He recently had undergone some medical treatment for a chronic, persistent problem. Unfortunately, he didn’t have any insurance. He couldn’t work and he didn’t have any accrued sick time, so he couldn’t earn any money. As a result, he couldn’t pay his monthly bills and couldn’t make payment on his medical bills. All of his creditors are now coming after him. Some people in this type of situation might file a Chapter 7 bankruptcy and wipe the slate clean. The medical problem has not yet been resolved and he is going to need additional medical treatment for which he does not have medical insurance.

What we do sometimes in cases like this is to put someone into a Chapter 13 plan, which would last, at a minimum, three years. If, during that three year period after filing the Chapter 13 case, he incurs an extraordinary amount of uninsured or unreimbursed medical bills he can’t handle, we have the luxury of switching or converting the Chapter 13 case to a Chapter 7 case. Whereas you can only list the debts that are incurred as of the time of the filing for bankruptcy, you can move that line down the road to the point of conversion. So, if between the filing of the Chapter 13 and the conversion of the case he incurs all of those unreimbursed medical bills, we can add them to the list. If those medical bills are dischargeable, we’ll discharge them in that converted Chapter 7. It’s a way to insure against uninsured medical bills during that three year time-frame.

Jess Smith: That is a legitimate reason for people to file Chapter 13. Don’t take garnishment now, with the right to convert later.

CH: So, for a minimum payment of $125 a month, which is probably cheaper than any insurance premium, people in this position insure against those uninsured medical bills during that three year timeframe. Now, if they don’t incur any additional medical bills, they can complete their plan and get their discharge, but if those medical bills are more than they can handle, that’s a reason to switch it over to a Chapter 7.

This particular client can’t go back to work for a couple of more months, so we are going to wait to file the case until that time. Chapter 13 used to be referred to as a wage earner plan and was designed for people who had regular steady income above and beyond their monthly living expenses. Without that regular steady income, he can’t propose a feasible plan. So, he is going to be released by his doctor and go back to work and that is when we are going to file. He’s still worried that he is still going to have this persistent problem that would require additional medical treatment and incur those unreimbursed medical bills.

If a medical condition and medical bills are causing severe financial hardship, contact us to discuss possible options that will allow you to get back on your feet and out of debt.

Foreclosure, Second Mortgage, and Bankruptcy

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Avoid Foreclosure and Keep Your HouseWhen foreclosure of a house is a threat, many homeowners seek debt relief through bankruptcy. A fairly common theme in this type of situation is the presence of a second mortgage. Another common aspect in this scenario is that homeowners are unaware of the second mortgage on their home. How does this happen?
We recently discussed foreclosure and second mortgages with Christopher Holmes and Jess M. Smith, III, partners at Tom Scott & Associates, P.C. Below is a transcript of that conversation.
Jess Smith: We’ve recently had several clients come to us with a foreclosure problem. We’ve been ready to file their bankruptcy, thinking they only have one mortgage on the property that is under water, and it turns out they actually have a second mortgage, because they’ve been in trouble before and entered loss mitigation. They basically granted a second mortgage that is now held by the U.S. Department of Housing and Urban Development (HUD) with no minimum payment and no interest. But, the loan is due either in 30 years or upon sale of the house or upon refinancing of the existing note. The majority of people who come to us to get help with their first mortgage have no recollection of this second mortgage.
Q: These are secured loans?
Chris Holmes: Yes, these are secured loans. They were behind right before closure so they took the arrearage and made it into a note and second mortgage with no payment due.
JS: So they don’t get a monthly bill. They didn’t do a loan modification on the original mortgage, they default on it again, and so they’re sitting here in a foreclosure and they bring in the foreclosure documents and we have to tell them they have a second mortgage. If we can prove they are still under water with the first mortgage, we can get rid of that HUD mortgage in Chapter 13.
Q: Can you expand on the different types of second mortgages you can acquire other than from a bank?
JS: What was probably more common 10 to 15 years ago was when people would get what was called an 80-20 mortgage. If they didn’t put enough money down to qualify for a certain loan, so they would get a loan for 80% of the total amount financed and then get a subsequent loan for 20% of the amount financed, in order to get the lower rate on the first mortgage. So they would have two mortgages basically granted at the same time when they purchased the house.
CH: Instead of borrowing 100% from the first lender, the lender would let them borrow 80% as a first mortgage. They would then borrow the other 20% and turn that into a second mortgage. The loans were then recorded within minutes or seconds of each other. We saw that quite a bit 10 to 15 years ago. Now, we hardly see that at all.
Q: Are there any other agencies besides HUD that provided those types of second mortgages?
JS: It’s usually just the Department of Housing and Urban Development. I think the way these mortgages are created is when the homeowner gets in trouble the first time, HUD will cut a check to the original lender to bring the debt as current; they’ll restructure the interest rate and the payment terms, but HUD just doesn’t give the default amount to the lender. They hold that as a second mortgage. Most people either just forget about it or they have so many pieces of paper shoved in their face – when they know this is how much I have to pay on the first mortgage – they have no recollection that there is a second mortgage out there. So they come see us very late in the foreclosure process.
Q: You mentioned that they may not even be making payments on the HUD loan. What are the various types of terms that could be applied to that second loan?
JS: Typically, the terms are no interest, a maximum maturity of 30 years, or the loan becomes due upon sale of the real estate or the refinancing of the first mortgage.
Q: If it is a no interest loan, does the borrower need to be making monthly payments on that amount?
JS: They are not required to, but the odd thing is that they can get rid of it in Chapter 13 bankruptcy. if when they file the bankruptcy they owe more on the first mortgage than what the house is worth.
Q: What exactly does “get rid of” mean in regards to the second mortgage?
JS: Basically, a lien strip.
CH: It’s called a motion to avoid a wholly unsecured mortgage. So as long as we can persuade the judge that the value of the home is exceeded by the payoff on the first mortgage, there’s no equity to which the second mortgage can effectively attach, because they are wholly unsecured, the law says you can get rid of, or as we say, strip, or avoid that – turn them from a secured creditor into an unsecured creditor, so down the road when the house is to be sold, there is no need to pay that second mortgage. It’s wiped out just like a credit card debt is wiped out.
Q: is that for both Chapter 7 and Chapter 13?
JS: That’s only available in Chapter 13.
CH: That’s one of the primary reasons we recommend Chapter 13 for some people in that circumstance. In a Chapter 7, you’re stuck with that second mortgage. Only in Chapter 13 do we have the clout to get rid of it.
JS: I met with a gentleman earlier today whose house on the east side of Indianapolis is up for Sherriff’s sale in a couple of weeks. He can’t find his foreclosure complaint. All he brought in was the notice of the sale. I went to the state court chronological case summary, and the Department of Housing and Urban Development is named as a defendant in the foreclosure. So, before we file the case, I have to see if there is a second mortgage, and if there is, I need to pay real close attention to what his house is worth to see if there is the possibility of eliminating this debt he didn’t even know he had.
Q: In a Chapter 7, they’re going to lose the house?
CH: It’s either make arrangements to pay all mortgages to keep the home or surrender the home to get rid of the debt.
Q: In a Chapter 13, is that second mortgage, which you’re stripping from being secured, rolled over into the pool of creditors so that you’ll still eventually pay pennies on the dollar for that amount?
JS: It’s converted into unsecured debt – lumped together with credit cards and medical bills, etc. – that you might eventually pay anywhere from 1-cent to 100-cents on the dollar. It just depends on what your income ability is to pay back back the debt. But it is converted to an unsecured debt.
Q: Is there a lesson a reader might learn from this case? Why is he filing for bankruptcy?
JS: The gentleman is about 50 years old and currently employed as a machine operator. He earns about $45,00 a year. His wife, who is not filing for bankruptcy, is employed by the government. She earns about $50,000 annually. The primary reason for his financial problem is that he and his wife don’t communicate about income and expenses. The house and the mortgage are both in his name. Her money is her money and his money has to pay for the house. They’ve only had the house for three years, so maybe they just bought too much house. I suspect it is a pattern of lack of communication that has put them in this spot, because he doesn’t seem to know much about her bills and expenses, but she makes over half of the household income.
Q: Did this gentleman come in to see you at you at your East Indy office?
JS: Actually, he came into the North Indy office, because it’s open on Saturday.
If your mortgage lender is threatening foreclosure on your house, contact us to discuss possible options that will allow you to stay in your home while you work to get out of debt.
Additional Resource from HUD: Avoiding Foreclosure

Auto Loans and Bankruptcy: How to Avoid Repossession of Your Vehicle

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We Can Help You Keep Your Car

Are you behind in your monthly car or truck payments to the point where you are unable to satisfy your bank or financial institution and they’ve placed the loan in default? If you answered “Yes,” there may be a way out of your tough situation.

If you’re having financial troubles and are desperate to avoid repossession of your car or truck, filing for a Chapter 13 bankruptcy may be the solution that can help you keep your vehicle. In this type of situation, you would be consider the “debtor” and the lender would be considered the “creditor.”

How Your Auto Loan Became Upside-Down

Let’s assume the loan is more than 2 ½ years old (at least 910 days before filing date) and the debt is “upside-down,” which means the unpaid balance of the loan is more than the value of the vehicle. Also, we’ll assume the loan is at a high rate of interest, perhaps 18-21%.

An example of this type situation could be that you bought a new $35,000 car three years ago on a six-year loan. The value of the car has since depreciated to only $12,000. However, because of the high interest rate, you still owe a loan principal amount (i.e., balance before monthly interest is added) of $22,000. In this case the “secured” value of the vehicle is only $12K, because that is the current replacement value if the car was repossessed and sold by the creditor.

Thanks to Chapter 13 of the U.S. Bankruptcy Code, you can force the bank to let you keep your car and, in effect, refinance the loan for the current replacement value. This process is known as a “cramdown” and it is not available in a Chapter 7 bankruptcy.

How a Cramdown Helps You Keep Your Vehicle

In a cramdown, the creditor would need to accept only the value of the vehicle as the principal amount for the refinanced loan ($12K in the example described above), plus only about 4.75% interest per month. This would significantly reduce your monthly auto loan payment.

The lending institution would then discharge the additional amount you owed, as well as the interest due based on the original higher rate. The court will determine the actual interest rate you’ll pay, which will be based on the current prime rate when that is determined.

The remaining amount of the loan principal that is not crammed down will be lumped into the pool of your other nonpriority unsecured debts ($10K in the above scenario). You will only pay back pennies on the dollar of the discharged amount, as part of your monthly payment to your bankruptcy trustee, which is distributed to all of your creditors.

At the end of the Chapter 13 plan, which will last 3-5 years, the creditor must provide you with a lien-free title to your car or truck.

Learn More Auto Loan Cramdowns and Bankruptcy

To learn more about how filing for bankruptcy and pursuing a cramdowm can help you avoid having your car or truck repossessed, and the other ways it can you relieve the pressure of your financial situation, submit the form above or contact us to schedule a free consultation.