Chapter 13- to file or not to file ?

Filing Bankruptcy is a very difficult decision, there are many factors, and many emotional factors in play. However, you need to realize that, in many respects, bankruptcy is a financial “tool”. A tool that is no different than any other financial tool, like credit cards, car loans, certificates of deposits, life insurance etc…they are all financial tools that server a particular purpose. At some point, and for whatever reason, if you are reading this forum, your debt load is becoming too much to handle, but you are reasonably employed and probably cannot file for a chapter 7, thus, how do you determine if a chapter 13 is the right tool for you?

In summary, the decision methodology is a comparison between a standard debt reduction 5 year plan, and a chapter 13 5 year plan. If you can’t get your self out of debt in 5 years (and were talking about unsecured debt, i.e. credit cards, lines of credit, some types of business debt, etc), then a Chapter 13 is probably right for you. Let’s do an example.

You: have 4 credit cards, 2 car payments, a mortgage, and the typical household expenses, and no meaningful savings to speak of, (at least not any savings you can get out without incurring serious penalties and fees to get). Credit Card (a) $12,000 at 14%, (b) $8,000 at 11%, (c) $9,000 at 8%, and (d) $3,000 at 18%. (total debt of $32,000)

First, assuming a standard 2% minimum payment, your combined minimum payments would be $640 per month. Granted, each month, the minimum payment would decrease a little…but we don’t care, if you were to only make minimum payments, as they decreased, it would take you 524 months (43.6 years) to pay off that debt.

Step one…stop using credit cards, do a budget, cut expenses, where possible and see how much money you have left over at the end of the month to pay down debt. Let’s assume you are able to come up with $900 per month to pay to the credit cards each month.
Step two, rank your credit cards by interest rate, highest to lowest.
Card (d) 18% $3,000
Card (a) 14% $12,000
Card (b) 11% $8,000
Card (c) 8% $9,000
Step three, pay minimum payments on cards (a), (b) and (c), and devote all of your remaining funds to Card (d), the card with the highest interest rate.

Thus, Payments would be…
Card (d) $320 per month
Card (a) $240, Card (b) $160, Card (c) $180

1-11 months, Card (d) would be paid off in 11 months.
Balances on Card (a) $10,833; card (b) $7,002; card (c) $7,635

Devote the $320 payment you were making to card (d) to the card with the next highest interest rate, in this case, card (a). Thus, total monthly payment to card (a) is $560 ($320 + $240).

12-34 months. Card (a) is paid off in month 34. The balance on card (b) is now $4,561; and the balance on card (c) is $4,437. Do the same as before, take your payment from card (a), and apply it to the card with the next highest interest rate, in this case Card (b). Your new monthly payment to card (b) is $720

35-41 months, Card (b) is paid off in month 41. The remaining balance on card (c) is $3,362. Devote your entire excess funds to paying off card (c) for a total monthly payment of $900 per month

42-45 months. Card (c) is paid off in month 45. And you have paid off your credit cards.

Note, over this period of time, the minimum payments on the cards will go down as you pay them off, since the minimum payment is generally 2% of the balance owed. My plan above assumes you continue to make the same payment each month as you did in month one. For example, in month 1, the minimum payment on Card (b) is $160, but in month 11, the minimum payment would be around $140-$145. So you could probably save yourself another couple months if you made the actual minimum payment and continually devote the extra to the highest rate card. However, my plan above, assume you make a $160 per month payment to Card (b) during the plan, until it is Card (b)’s turn to have the excess funds applied to it.

Since this plan is doable in under 60 months (5) years, you probably should not file chapter 13. Also consider this, if you were to file chapter 13 and pay off your debt (note, in a chapter 13, interest stops accruing) and paid into your chapter 13 plan $900 per month, you would be in the plan for 40 months (note, the trustee gets a 10% fee, and then you have attorneys fees). You only save yourself 5 months worth of payments in a chapter 13, hardly worth it. Another benefit, given the length of the plan, by month 45, you would probably have either paid off, or be close to paying off your cars. If you still had a balance on your cars, you can devote the money you were paying to the credit cards to over-pay your car payment, and pay them off early . Just think, in less than 4 years, you could be credit card debt free, and have your cars paid off. Think of how much money that would save you per month. Then, you can really start doing some serious saving.

However, if you go through this exercise and realize, you cannot pay down your debt in under 60 months, then your next stop would be a consultation with a consumer credit counseling firm, and if they can’t help, then chapter 13 would be for you.