If you file for Chapter 13 bankruptcy, you will repay creditors, in part or in full, through your Chapter 13 plan over three to five years. You cannot decide the order in which your creditors are paid. Instead, bankruptcy law sets forth the order that your bankruptcy trustee must pay your debts. Usually the trustee pays them in this order: secured debts first, followed by priority debts, and then unsecured debts. (Learn about secured, unsecured, and priority claims.) You may pay some of those debts in full through your plan, and others just pennies on the dollar.
How the Payment Process Works in Chapter 13
You can use a Chapter 13 Bankruptcy to manage your debts. Through Chapter 13, you can eliminate some debts, alter some types of contracts with existing creditors, and pay some debts in full. During the Chapter 13 process, you develop a plan outlining precisely how you will pay your creditors. You make monthly payments to the bankruptcy trustee and the trustee then distributes those payments to your creditors according to your plan (To learn more, see The Chapter 13 Repayment Plan).
When Do You Start Making Payments?
Your start making payments into your Chapter 13 plan within the first month of filing. However, the trustee does not distribute the payments to creditors right away. Instead, the money goes into the Chapter 13 trustee’s trust account, where it sits until the court confirms your plan.
What Determines Who Gets Paid First?
Bankruptcy law determines the order in which the bankruptcy trustee will pay your creditors. When you devise your Chapter 13 plan, it must conform to these bankruptcy rules. After the court confirms you plan, the trustee distributes the money in the trust account according to the terms in the plan.
After plan confirmation, you continue to make monthly plan payments. The trustee distributes these payments (called post-confirmation payments) in the same manner as those in the trust account. If your plan is dismissed before confirmation, generally the bankruptcy trustee will return the amount remaining in the trustee account to you.
Payment Order in Chapter 13 Bankruptcy
The order that the trustee must pay your creditors and others is generally as follows:
- attorney’s fees and trustee fees
- secured debts
- priority debts, and
- unsecured debts.
Chapter 13 Trustee Fees and Attorney’s Fees
Unless you pay your attorney in full before filing your case, the Chapter 13 trustee will pay your bankruptcy attorney’s fees before your other debts.
You will also have to pay the Chapter 13 trustee fees in an amount roughly equal to 5% to 10% of the total amount that you will pay into your Chapter 13 plan (the precise amount differs by state and by trustee). The trustee gets his or her fees throughout the case. Whenever the trustee distributes money to a creditor, he or she will take the allotted percentage out to cover the trustee fees.
Secured debts are those for which a piece of property serves as collateral for payment of the debt. Examples include car payments and mortgages. Often debts incurred for new furniture are also secured – the furniture serves as collateral for payment.
How you or the trustee pays your secured debts varies, depending on the type of debt (mortgages get special treatment) and what you intend to do with the property that serves as collateral.
If You Want to Keep the Property
If you plan to keep the property serving as collateral, then you must pay the secured debt through your Chapter 13 plan. You may be able to pay the debt at a reduced interest rate. And in some instances you may be able reduce the total amount due to the value of the property. This is called a cramdown. (Learn more about cram downs and interest rate reductions in Cramdowns in Chapter 13.)
You don’t have to pay off secured debts before the trustee distributes part of your plan payments to other creditors. But you must pay off secured debts before you receive your discharge. Talk to a local bankruptcy attorney to determine how much you will likely have to pay to keep certain property.
If You Don’t Want to Keep the Property
If you do not want the property, you may surrender it (give it back) to the secured creditor, and any unpaid balance owed to that creditor becomes an unsecured debt.
Adequate Protection Payments
Sometimes secured creditors are allowed to receive “adequate protection” payments before the confirmation of your plan. The purpose of adequate protection payments is to offset the depreciation of the property (for example, your car).
The trustee can distribute adequate protection payments to the secured creditor before the court confirms your plan. In this way, creditors eligible for adequate protection payments receive payment before all other creditors, including your bankruptcy attorney’s fees.
Mortgage payments are treated differently than other secured debts. In some jurisdictions, you may pay your mortgage lender directly on a regular basis outside of the Chapter 13 plan. This keeps you current on the loan.
However, if you are behind on your mortgage, bankruptcy law treats that amount (called the arrearage) just like other secured debts. The bankruptcy trustee will pay it on a pro rata basis with your other secured debts. (Learn more about what happens to mortgages in Chapter 13 bankruptcy.)
Priority debts include tax debts and child support arrears. You cannot successfully complete your Chapter 13 case unless you pay these debts in full through the life of your Chapter 13.
Creditors can agree to different treatment of their claims. But absent any agreement to the contrary, the bankruptcy trustee will pay priority creditors on a pro rata basis with the other priority creditors. The trustee will start paying priority creditors before any money is distributed to unsecured creditors. Sometimes a Chapter 13 plan will call for the trustee to repay secured debts in full before distributing any money to unsecured creditors. Other times, a plan may permit payments to unsecured creditors while the priority debts are still being paid.
Nonpriority, Unsecured Debts
Unsecured debts are any debts that are not secured by collateral or that are not priority debts. These include medical debts, credit card debts, paycheck advance loans, and personal lines of credit.
Student loans. Although student loans are unsecured debts, they get different treatment. Unlike most types of unsecured debts, you cannot discharge student loans at the end of your Chapter 13 case unless you can prove undue hardship. Often the court will allow you to reduce the amount of your student loan payments will you are in bankruptcy. (To learn more, see Student Loans in Chapter 13 Bankruptcy.)
The Chapter 13 trustee generally pays unsecured debts on a pro rata basis after paying all secured debts, priority debts, and attorney’s fees. Sometimes, though, the trustee will pay unsecured debts alongside secured debts depending on how you elected to treat the secured debt in your plan (although your secured creditors must get something before the trustee starts paying unsecured creditors or priority creditors). Often unsecured creditors receive very little, if anything, through a Chapter 13 plan.
What If You Want to Pay a Creditor First?
Some debtors are interested in the order of payments through the Chapter 13 plan because they want to make sure that a family member, friend, local doctor, or local bank gets repaid for an unsecured debt. If you are in this situation, talk to a local bankruptcy attorney to discuss your options. Making a large payment to a creditor before filing bankruptcy could complicate your bankruptcy and cause headaches for the very creditor that you tried to protect.