What is Chapter 20 bankruptcy?

Some people struggling with overwhelming debt find that bankruptcy is the best debt relief solution for their unique situation. Determining which form of bankruptcy to file is largely dependent on the amount and types of debt held, and the financial situation of the individual or married couple. When considering bankruptcy, most people first learn about Chapter 7 and Chapter 13, named for the Bankruptcy Code chapters that govern how they work. But a lesser-known arrangement, Chapter 20 bankruptcy, functions as a hybrid of the two. 

Why it’s always Chapter 7 first followed by a Chapter 13

Chapter 7 bankruptcy generally eliminates unsecured debt and most personal liability. As this form of bankruptcy essentially “wipes the slate clean,” it is often the quickest path to a fresh start. However, in order to be eligible for Chapter 7 bankruptcy, an individual or married couple must earn less than the median income for their state. To prove this, the debtor must pass something called the means test. 

Although Chapter 7 bankruptcy is often the choice for qualifying individuals with unsecured debts, there are certain things it cannot do. Namely, you cannot manage arrearages on car loans and mortgages through Chapter 7. You also cannot strip unsecured second mortgages or request extra time to resolve non-dischargeable debts. This is where Chapter 13 comes in.

Chapter 13 imposes debt limits on the amount of debt you can have. Your total amount of unsecured and secured debt cannot be greater than the limits set by the federal Bankruptcy Code. If you have too much unsecured debt to qualify for Chapter 13, filing Chapter 7 will effectively eliminate that issue by allowing you to discharge your unsecured debt first.

Let’s say, for example, that you haven’t been able to work due to a serious injury, which has also resulted in significant medical bills and credit card debt. To make matters worse, you have fallen months behind on your mortgage, your home equity loan is maxed out, and your house is worth substantially less than what you owe. Bankruptcy may be the only option to resolve your mounting financial problems. In such a situation, your unsecured debts may disqualify you from filing Chapter 13. But you can resolve that problem by first filing Chapter 7.

Although bankruptcy works by essentially breaking a contract between you and some creditors, there may be certain secured loans you wish to keep in place. If, for example, you want to discharge your credit cards and medical bills, but you want to keep your vehicle loan untouched, you can do so through the process of reaffirmation. To reaffirm a debt is to agree to remain responsible for that debt. 

Filing a Chapter 13 after a Chapter 7 is referred to as Chapter 20 bankruptcy. It’s important to note that although Chapter 13 can be filed immediately after Chapter 7, it doesn’t have to be. It can even be done years later. If you find yourself in a situation where you have too much unsecured debt to qualify for Chapter 13, but multiple mortgages and/or vehicle loans with underwater balances, filing Chapter 7 and 13, one after the other, may be the right debt relief solution for you. 

Reorganizing what’s left through Chapter 13

You can handle the unsecured debts by filing Chapter 7, but that doesn’t help you keep your house and vehicles. Once you have discharged your unsecured debts through Chapter 7, however, your unsecured debt load will be eliminated, and you’ll no longer have “too much” debt to qualify for Chapter 13. And Chapter 13 does provide relief for secured debts, such as mortgage and vehicle loan arrears. 

Instead of wiping your debts clean, Chapter 13 provides extra time to pay off non-dischargeable debts, such as child support, and tax debts. The repayment plan in a Chapter 13 bankruptcy typically lasts for three to five years. At the end of the repayment plan, most remaining balances will be wiped away as dischargeable debts. 

Stripping your second mortgage

If you have a first and second mortgage (also called a home equity loan or junior mortgage), you cannot eliminate the bank’s security interest in your home through a Chapter 7 bankruptcy. As a lien on your home, you have no choice but to pay this secured debt as required, or the second mortgage lender will likely foreclose on your home, if not right away, then eventually, once the market value of your property is enough to ensure they’ll receive some funds following the foreclosure. Chapter 7 doesn’t resolve secured debts, but Chapter 13 is a different story. 

If you have a second mortgage, but no equity because of other liens that come ahead of it on your home’s title, a Chapter 13 bankruptcy may allow you to “strip” the second mortgage from the property. The lack of equity allows the court to classify your second mortgage as an unsecured loan. Once the court declares the second mortgage to be unsecured and the lien is stripped (or avoided), you will no longer be required to make monthly payments on that debt. Rather, you will pay only what you can afford to pay for the duration of your Chapter 13 payment plan. And when the three-to-five year payment plan is over, the lien is released. 

You can only strip a home equity loan if your first mortgage is underwater, however. If the market turns and your property value surpasses the outstanding balance on your first mortgage and other liens, you will have lost the ability to separate the second mortgage from the property, and that creditor may foreclose on your home. 

It should be noted that in certain districts, the bankruptcy court will not allow lien stripping of a second mortgage if you are not eligible for a discharge in Chapter 13. An experienced bankruptcy attorney can help you understand this complex process and if you are eligible to take advantage of it. 

Reorganizing your car loan

Let’s say you took out a five-year auto loan for a car, three years ago. Your loan balance is $18,000 but due to high mileage, the car is only worth $7,000. Since it was your only vehicle and your interest rate wasn’t all that terrible, you reaffirmed this loan as part of your Chapter 7 bankruptcy. In a subsequent Chapter 13 bankruptcy, you can: 

• Reduce the payoff amount to the value of the vehicle, because  the car was purchased more than 910 days ago

• Lower the interest rate to between prime+ 1 to 3 percent

• Pay off your vehicle loan through the Chapter 13 payment plan

If you have debt in the form of a car loan and you wish to keep that car, you can include that payment as part of a Chapter 13 repayment plan. If you purchased the vehicle less than 910 days before filing bankruptcy, you will have to repay the entire value of the loan, but the interest rate can be reduced, resulting in a lower payment. If, however, the vehicle was purchased more than 910 days ago, you will only be responsible for a prorated payment based on the vehicle’s actual value. 

Some other Chapter 13 tools

Mortgage and vehicle loans are not the only types of debt that can be resolved or managed in Chapter 13. Other debts that are non-dischargeable in Chapter 7 bankruptcy, such as tax debt and certain property settlement obligations, may be included in Chapter 13 payments. As mentioned earlier, you can also include a mortgage arrearage in your repayment plan if you’ve fallen behind on your mortgage. Other debts that can be discharged in Chapter 13 but not Chapter 7 include:

• Certain divorce property settlements

• Homeowner association fees

• Civil fines and penalties, including traffic tickets

• Credit card or loan debt acquired paying off tax debts

In addition to allowing you to pay what you can afford toward your total debts, filing Chapter 13 may also allow you to discharge certain debts for which no discharge is available under Chapter 7 (assuming your Chapter 7 filing was more than 4 years before your Chapter 13 filing), keep real estate out of foreclosure, remove second or subsequent mortgage liens, and reduce vehicle loan payments. You will make one monthly payment, based on your budget, that encompasses all of your debts. Upon the end of your three-to-five year repayment term, any dischargeable debts that remain will be wiped away so you can start with a clean slate. In addition, interest will stop accruing on any dischargeable debt during the repayment plan, so even if you can afford to pay back the entire amount owed within that time frame, Chapter 13 will still save you money. 

Conclusion

For some people, Chapter 20 bankruptcy is the best path to debt relief. But it isn’t for everyone. If you have non-exempt assets that you wish to protect, they will not survive the process. This is because the first step in a Chapter 20 bankruptcy is filing Chapter 7, and Chapter 7 bankruptcy involves selling off any non-exempt assets. 

More than likely, however, the assets you wish to keep will be exempt. In this case, the Chapter 20 strategy may provide greater relief than Chapter 7 or 13, alone. To make Chapter 20 bankruptcy work, you must be eligible to first file Chapter 7, receive a discharge, and then qualify to file Chapter 13. 

Each type of bankruptcy has its own set of qualifiers. A Chapter 7 filer must be able to pass the “means test” to qualify, and to be eligible for Chapter 13, you must have enough income to support monthly plan payments. The best advice for anyone considering this form of debt relief is to consult with an experienced bankruptcy attorney about your bankruptcy case. Although most law firms have multiple practice areas, make sure you work with a lawyer who specializes in bankruptcy filings. You can also take advantage of Upsolve’s free web app, which helps eligible individuals file Chapter 7 bankruptcy without a lawyer.