Bankruptcy can’t write off certain kinds of debts. Chapter 13 enables you to prevent liens hitting your home from those debts.
Our last blog post was about how Chapter 7 “straight bankruptcy” helps prevent liens on your home arising from special debts. These are debts that can’t be discharged—written off in bankruptcy. Examples of these special debts include recent income taxes and unpaid child or spousal support.
But Chapter 7 has serious practical limitations on how much it can prevent those liens on your home. Chapter 13 “adjustment of debts” is often a much better tool for dealing with income taxes and support. Here’s how we introduced this earlier, focusing now on the Chapter 13 side of this.
Preventing Liens on Your Home from Debts that Can’t Be Discharged
A Chapter 13 case protects your home from liens much better than Chapter 7. It doesn’t leave you on your own to deal with any remaining debts. Chapter 13 protects you and your home throughout the time that you are paying off those debts through a flexible 3-to-5-year payment plan.
You and your bankruptcy lawyer put together that payment plan based on how much you can afford to pay. The plan is then reviewed and approved by the bankruptcy judge assigned to your case. Creditors have some say about this, but are limited in the arguments they can raise.
Throughout the course of the payment plan, all of your creditors are prevented from putting liens on your home. That includes the especially aggressive creditors like the IRS, state tax entities, ex-spouses, and support enforcement agencies. Then by the time your Chapter 13 case is completed, those special debts have been paid in full or paid current. As a result they can’t threaten you or your home any more.
Here’s how this works in practice.
Assume that you own a home with some equity—for example a $250,000 home with a $225,000 mortgage. You have no liens on the home’s title so your home has about $25,000 in equity.
Now also assume that you are entitled to a homestead exemption of $25,000. So, all of the $25,000 in your home’s equity is protected by this homestead exemption. This means that all of this home equity is protected from your creditors and from a bankruptcy trustee.
You want to keep your home and preserve the equity you have in it. But you have serious financial problems. You have a whole bunch of credit cards and other debts amounting to $60,000 that are past due. Plus you’ve fallen behind on your $1,000 per month child support payments by 5 months, or $5,000. And you owe $12,000 in income taxes to the IRS for last year and the year before.
The credit cards and miscellaneous debts can be discharged in bankruptcy, but the recent tax and support debts can’t be. So if you file a Chapter 7 case you’re on your own dealing with the surviving tax and support debts.
The Chapter 13 Solution
You’re not on your own with these debts under a Chapter 13 case. You and your home are protected. Here’s how this option would work in this scenario.
- As to the $12,000 income tax debt that you must pay, you have up to 5 years to do so. During that time the IRS or state can’t take any collection action against you, or your income or assets. That includes not recording any tax liens against your home.
- In most situations no ongoing interest or penalties would accrue on that $12,000 tax debt during the case. That could save you a fair amount of money, enabling you to pay off the taxes that much faster.
- You’d have huge flexibility in the payment terms. The payment amounts would be based on what you could afford. Certain other debts could be paid ahead of the taxes, such as the child support, or to catch up on a vehicle loan or home mortgage. Also, the timing of the tax payments could change if your circumstances changed during the course of the case.
- As to the $5,000 child support arrearage, you are required to catch up on this, and again you have up to 5 years to do so. Your ex-spouse and support enforcement agency cannot take any collection action against you during this time. That is, they can’t as long as you meet certain strict conditions. You must keep current on any ongoing support payments, and on your Chapter 13 plan payments. But if you just meet these conditions, you and your home are protected.
- As to the $60,000 in credit cards and other miscellaneous debts, in most cases you would only need to pay those if and to the extent you had money left over to do so. That means that your available funds would first go to pay the tax and support debts. And that’s after you are allowed to spend a reasonable amount of money on living expenses.
- At the completion of your Chapter 13 payment plan whatever part of that $60,000 in general debts that had not been paid would be discharged—written off forever. Those creditors would never be able to sue you and get a judgment lien on your home.
- At the point when your Chapter 13 case is finished, you will have paid the taxes and support arrearage in full. So you’d not owe anything to those creditors. They’d have no debt upon which to record a lien on your home.
- You would have successfully and permanently prevented the IRS/state and ex-spouse/support enforcement from placing a lien on your home.