Advanced Bankruptcy Strategy: Using Chapter 13 to Save Your Home, Then Converting to Chapter 7
As a bankruptcy law attorney, I often hear: “I’m buried under credit card debt, but I’m also a few months behind on my mortgage. How do I save my house and get a fresh start?” For these clients, the powerful strategy of conversion, specifically from Chapter 13 to Chapter 7, is often the answer.
By Alexander Hernandez, J.D., Professor, and Author of Consumer Bankruptcy Law (Routledge).
If you file Chapter 7, you get rid of the unsecured debt, but you can’t force the bank to take a payment plan on your mortgage arrears; the foreclosure risk remains. Just by filing Chapter 7, the bankruptcy trustee will take your house, sell it at auction, and use the proceeds to pay your creditors.
If you file Chapter 13, you can save your home by making payments on the arrears throughout the life of the plan. However, once you catch up with the arrears, payments begin on your unsecured debt, such as your credit cards, and depending on your non-exempt assets, the amount could be substantial and unaffordable.
However, by filing Chapter 13 first, then converting to Chapter 7, you might get the best of both worlds.
Filing Both Chapters in Bankruptcy. The Conversion Strategy
When filing both Chapter 13 and 7, the key is in the timing.
The Chapter 13 “Arrears Cure”
You begin by filing for Chapter 13 reorganization. The primary purpose is to catch up with the missed payments (arrears) of your mortgage. Remember, this option isn’t possible with Chapter 7.
The moment you file, the Automatic Stay kicks in, immediately stopping all collection efforts, including foreclosure or repossession. Your Chapter 13 plan is then designed to pay back the arrears (the amount you are behind) over a period of 3 to 5 years, while you continue making your regular monthly payments on time. How long it takes to catch up on your missed payments varies per case and financial situation, so it will be different for everyone.
Wiping Out Your Unsecured Debt with Chapter 7 Bankruptcy
Once you have successfully brought your mortgage or car loan completely current, you move into the second phase of your bankruptcy plan, and that is paying unsecured creditors.
Understanding the Liquidation Test
Converting to Chapter 7 from 13 is not based solely on catching up with the arrears because there is the critical Liquidation Test, also known as the Best Interests of Creditors Test.
The Liquidation Test requires that you prove in your Chapter 13 plan that you can pay back the unsecured creditors as much as they would have if your non-exempt assets were liquidated in a Chapter 7 bankruptcy.
For example, suppose you had $10,000 in non-exempt assets. In a Chapter 7 bankruptcy, that is the amount that gets paid back to the unsecured creditors. If you cannot afford to pay back that amount, the bankruptcy trustee will seize the assets and sell them at auction. The net proceeds are distributed to the unsecured creditors.
Under the Liquidation Test, in a Chapter 13 bankruptcy, creditors must receive the same amount they would have received in a hypothetical Chapter 7 bankruptcy.
Why the Liquidation Test Isn’t Possible for Everyone
If you have significant non-exempt equity in assets, your Chapter 13 plan might have required you to pay a high percentage of your unsecured debt just to meet the Liquidation Test. If that were the case, converting to Chapter 7 might not be possible without the risk of losing those assets.
The success of the Chapter 13-to-7 conversion strategy is therefore dependent on the value of the non-exempt assets. If all of your assets are exempt, then the unsecured creditors would receive nothing in a Chapter 7 bankruptcy, and your Chapter 13 plan only has to cure the arrears.
Note that in this scenario, there is little to no disposable income available when comparing income (Schedule I) to expenses (Schedule J). If not, you wouldn’t qualify for Chapter 7.
The Professor’s Take
The Chapter 13 to Chapter 7 conversion is a powerful tool for debtors who are behind on secured debt but also need the relief of a Chapter 7 discharge because of substantial unsecured debt. It is a testament to the flexibility of the Bankruptcy Code when applied correctly.
If you are facing the dual threat of foreclosure or repossession and unmanageable unsecured debt, consider the Chapter 13 to 7 conversion. Note that the process is complicated and requires approval from the bankruptcy judge, so it’s not recommended that you represent yourself (pro se). On average, approximately three percent of pro se Chapter 13 filings are successful.
Professor Hernandez is an attorney specializing in consumer finance and debt relief. He is the published author of Consumer Bankruptcy Law (Routledge Publishing) and teaches law and finance courses in both English and Spanish for an international university.
Colleges and universities can purchase my bankruptcy law textbook directly from Routledge Publishing. Paralegals and students who are buying single copies can do so via Amazon Books. To access my YouTube channel, click this link. You can also listen to my podcast on Spotify.
You can learn more about filing for bankruptcy and the bankruptcy petition via this link. Information on the bankruptcy court system, contact information for trustees, and your state’s exemptions can be found here. The federal bankruptcy exemptions are listed here. The latest version of the 341 Meeting of the Creditors can be found here.
You can find additional categories by clicking below or by using the search feature at the top of this page:
Please note that the information on this site does not constitute legal advice and should be considered for informational purposes only.
Discover more from Bankruptcy.Blog
Subscribe to get the latest posts sent to your email.
You must be logged in to post a comment.