To answer this question, we should first explain the process of bankruptcy. The two types of bankruptcy are Chapter 7 and Chapter 13. Chapter 13 bankruptcy is often called a “reorganization.” You can file for Chapter 13 bankruptcy only if you have a source of regular income. This includes any regular type of income: wages, government benefits, alimony or support payments, for example. When you file for Chapter 13 bankruptcy, you create a written plan to show how you will pay off your debts over a set period of time, usually from future income. In Chapter 7, or liquidation bankruptcy, you may have to sell off some of your assets to pay your debts. Under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, an individual’s ability to file for Chapter 7 bankruptcy has been tightened, thus forcing more people to file Chapter 13.
Understanding the two different types of creditors is also important when considering bankruptcy. Your creditors are grouped into two categories: secured and unsecured. A secured creditor is one who has an ownership interest in property until you pay your debt. The classic example of this is a bank that holds the mortgage or deed of trust to your home. The bank actually owns your home until you pay back the money it loaned you. If you do not pay the loan, the bank can force the sale of your house. This procedure is called a foreclosure.
An example of an unsecured creditor would be a utility company. This type of company owns nothing of yours. The utility company would have to first sue you for what you owe and get a judgment in its favor before it could possibly make you sell anything to pay your debt. Credit card debts can be either secured or unsecured, depending upon what it says in the contract you signed.
In Chapter 7 bankruptcy, the unsecured creditors get only a portion, if any, of the amount you owe them. The bankruptcy trustee examines your estate to see if any assets can be sold to satisfy your debts. However, most property is considered exempt and cannot be sold. The trustee will sell the nonexempt property, divide the proceeds, and distribute them to your creditors. They divide up a portion of the money that is collected when your assets are sold.
In Chapter 13, you set up a plan to pay unsecured creditors installments at least the amount they would have received had you filed Chapter 7. Assuming that your home or other collateral is worth at least as much as you owe the bank, you pay the secured creditors your usual monthly installments plus you make arrangements to pay the back payments. If your home or collateral is worth less than you owe the bank, you may be able to reduce the amount of your monthly payments. The secured creditors usually end up receiving payments equal to the value of the collateral they hold, while the unsecured creditors often end up with significantly less than you owed them.
The bankruptcy assets are all your assets that are in the bankruptcy estate. Some assets are exempt from the bankruptcy estate and therefore cannot be used to pay off creditors. One thing you can exempt is your interest in your home, up to $25,000 in West Virginia. Equity is how much of the value of the home you would have after the mortgage is paid.
When you file Chapter 13 bankruptcy, you must create a written plan to show how you will pay your creditors. Your unsecured creditors must get at least as much as they would have had if you filed Chapter 7 bankruptcy. This amount is frequently as little as 10% of what you owe them. The Chapter 13 plan is usually spread over a period of time. This means that if you owed your unsecured creditors a total of $5,000, you may be able to pay them as little as a total of $500 over a period of three years. This would greatly reduce the amount of your monthly payments. In addition, your Chapter 13 plan must include provisions for your secured creditors. You will have to pay them an amount equal to the value of the collateral they hold. This would include making up past overdue payments as well.
Your Chapter 13 plan must be approved by the bankruptcy court. For this reason, you must have an income. You have to show that you could afford to pay future payments on your home, and other secured debts, plus a small amount each month on the payments you previously missed. You would also have to show that you could pay some amount to your unsecured creditors. Finally, you would have to show that you could make these payments and still have enough money to cover your daily living expenses. If your plan is approved, you do not have to sell your home to pay the debt.
If you don’t have any income, or you can’t make your house payments in the future, you may be required to sell your house. In these situations, you might be forced to liquidate your bankruptcy assets to pay your debts.
However, even in those situations where you cannot make your house payments based on your income, there may be other alternatives. One alternative may be to rent the house, and another may be to refinance the home. Of course, you want to avoid selling the home through foreclosure. Usually a house sold through foreclosure does not command the full value of the home. As a result, many times you end up losing your equity.
Bankruptcy is complicated. If you think you need to file for bankruptcy consulting a bankruptcy attorney may help you identify important details about the process that only an experienced professional is likely to know.
For more information, see: 11 U.S.C. §§ 109(e), 502, 507, 522, 1303, 1322, 1325, 1328 (2010); W. Va. Code § 38-10-4 (2011); James W. Martin Jr., Bankruptcy, in The West Virginia Practice Handbook Vol.1 (The West Virginia State Bar, Young Lawyers’ Division, eds., 4th ed. 1996).