- Consequences of Converting Your Chapter 13 Bankruptcy to Chapter 7
- Too much income to qualify for Chapter 7 bankruptcy;
- Avoiding asset seizure in Chapter 7 bankruptcy;
- The need to repay non-dischargeable debts such as tax and child support obligations;
- The need to save a home from foreclosure.
- Renewed Collections after Conversion to Chapter 7 Bankruptcy
- Renewed Threat of Foreclosure
- Possible Vehicle Repossession After or During Chapter 7 Bankruptcy
- Protection of Assets In Jeopardy
- Loss of Protection for Co-Debtors, Transferees, or Insiders
- Consequences of Voluntarily Dismissing Your Chapter 13 Bankruptcy
- The Consequences of Dismissing or Converting a Chapter 13 Bankruptcy: The Bottom Line
When a Detroit Chapter 13 bankruptcy becomes difficult to fund due to a change in life circumstances, it is tempting to consider dismissing the case voluntarily or converting your Chapter 13 to a Chapter 7 bankruptcy.
These are options that are indeed yours to exercise in the Chapter 13 process. In some cases, they are well worth pursuing. There does come a point in some Chapter 13 cases where the process has outlived its usefulness.
However, dismissing or converting a Chapter 13 bankruptcy can also be an option that is jumped at a little quickly.
Exiting the court-enforced protection of a Chapter 13 bankruptcy proceeding can carry serious consequences to your debt liability and to your assets.
Consequences of Converting Your Chapter 13 Bankruptcy to Chapter 7
There are significant differences between the Chapter 13 and Chapter 7 bankruptcy processes. A Chapter 13 can appear on a credit report for 7 years from the date of filing, whereas a Chapter 7 can appear for 10 years before falling off. If your case started as a Chapter 13 and later converts to a Chapter 7, it will be noted as a Chapter 7 on your credit report as well as records with the United States Bankruptcy Court .
Whether or not conversion from Chapter 13 to Chapter 7 is a good idea for you will greatly depend upon the reason you were in a Chapter 13 to begin with.
A few of the common reasons why people in Michigan enter the Chapter 13 process include:
Too much income to qualify for Chapter 7 bankruptcy;
Avoiding asset seizure in Chapter 7 bankruptcy;
The need to repay non-dischargeable debts such as tax and child support obligations;
The need to save a home from foreclosure.
Chapter 7 bankruptcy is a great option for discharging unsecured debt if your income is moderate and you don’t own any “out of the ordinary” assets or property.
It is not the better bankruptcy option for many people with more complex asset or income scenarios.
It is not the better form of bankruptcy for those attempting to save a home from foreclosure.
When you convert to Chapter 7 bankruptcy, all of the eligibility issues that were in question as of the date of your original bankruptcy filing return to relevance.
That is, you again need to worry about whether you earn too much money, own valuable assets, or whether non-dischargeable debt obligations or mortgage payments are current.
Renewed Collections after Conversion to Chapter 7 Bankruptcy
A Chapter 7 bankruptcy is only 4 months long, in most cases, whereas a Chapter 13 protects you from creditor collections for as long as 5 years.
Thus, thinking ahead to now-sooner post-discharge/post-bankruptcy period is crucial when contemplating a conversion from Chapter 13.
If your mortgage payment arrearage was not brought totally current during your Chapter 13 process, it is possible you will exit your converted Chapter 7 process free of credit card debt—but facing an immediate foreclosure sheriff’s sale.
Likewise, if you owe delinquent income taxes or child or spousal support, these collections will begin again immediately upon discharge of the Chapter 7. (In fact, domestic support obligations are not subject to the “automatic stay against collections” at all.)
Worse, not only will these types of debts be collected from you sooner, the interest and late-fees and penalties that have continued to accrue while you’ve been in the bankruptcy process, will also be collectible from you.
Depending upon how long it has been since you filed the original Chapter 13 (1 months vs. 3 years, etc.), this could provide a very unpleasant surprise.
Renewed Threat of Foreclosure
As noted, once the automatic stay lifts upon discharge of your new Chapter 7 case, your mortgage servicer will be able to resume (or being) any foreclosure process to which it is legally entitled under Michigan state law.
One of the primary advantages of a Chapter 13 bankruptcy is that it provides you the opportunity to repay mortgage payment arrears (along with ongoing mortgage payments) at 0% interest over a time-period as long as 5 years.
Likewise, in a Chapter 13 bankruptcy, you can also “strip off” second or third mortgages or “cram down” the value of a non-primary residence.
That is, you can treat some mortgage obligations not as “must pay” secured debt obligations but as dischargeable unsecured debt obligations. In other words, you can pay less for your home in a Chapter 13!
However, these mechanisms only work in Chapter 13 bankruptcy, and they require that you complete the Chapter 13 Payment Plan entirely.
Thus, if you make all of your required Chapter 13 monthly payment installments, you will exit the Chapter 13 process free of credit card and medical and other unsecured debt—and with current mortgage payments and zero arrears.
If you convert to Chapter 7 bankruptcy prematurely, you will discharge your unsecured debt but will not have solved any pre-bankruptcy foreclosure problem.
Possible Vehicle Repossession After or During Chapter 7 Bankruptcy
Likewise, arrears in car or other vehicle payments can also be brought current in Chapter 13 bankruptcy.
Vehicles can also be crammed down in Chapter 13 so that you pay only what the vehicle is worth in fair market value to the lender, discharging any balance owed as if it were credit card debt.
When you convert to Chapter 7 bankruptcy, you lose these options as the ability to cram down the balance or modify the interest rate only applies in a Chapter 13 bankruptcy case and once it is converted to a Chapter 7 the creditor can re-calculate the balance owed based on the original contract balance and interest rate.
Instead, you can expect, if you are behind on car payments, to have your auto lender file a motion for relief from the automatic stay in order to immediately repossess the vehicle—or to simply wait and repo it after discharge.
You will be, in Chapter 7, obligated to consider signing a document known as a “reaffirmation agreement,” even if not in arrears.
A reaffirmation agreement puts you back on the hook for the car loan, even though it is otherwise totally dischargeable in bankruptcy. In Chapter 7 bankruptcy, secured lenders are allowed to repossess your vehicle if do not sign a reaffirmation agreement. Even if your payments are current.
Protection of Assets In Jeopardy
In Chapter 13 bankruptcy, assets are never seized and liquidated. This is because, instead, you make a monthly plan payment that is used to repay some of what you owe to your creditors.
In Chapter 7 bankruptcy, there is no payment plan. The only way that creditors are able to be repaid any of the debt they are owed is through a property “liquidation” mechanism that enables the Chapter 7 Trustee (now) assigned to your converted case to seize any property worth more than the available statutory protections in place for that type of property.
Some percentage of people who file Chapter 13 bankruptcy rather than Chapter 7 do so in order to preserve property that would otherwise be liquidated by a Chapter 7 Trustee.
That said, the statutory asset protections (known as “exemptions”) offered in Chapter 7 are fairly robust. The vast majority of those filing Chapter 7 do not lose any property at all.
However, it will be a new concern for you when converting from Chapter 13. Did your home gain equity while you were in the Chapter 13? Does the “homestead exemption” that would have protected your home from liquidation when you first filed still cover the property’s value?
Loss of Protection for Co-Debtors, Transferees, or Insiders
The automatic stay injunction that protects you from creditor collections during your bankruptcy process protects not only you but also individual (human) co-debtors in a Chapter 13 bankruptcy. This is known as the “Co-Debtor Stay.”
In a Chapter 7 bankruptcy, the automatic stay protects only you. Not the mother or beloved aunt who co-signed a loan for you.
Further, the Chapter 7 Trustee has not only the power to liquidate assets in a Chapter 7 bankruptcy but also the power to retrieve cash or property that has been transferred for less than it is worth to friends, family members, even to a non-filing spouse.
Likewise, if you repaid a debt owed to a family member, spouse, or other so-called “insider” within the past year, the Chapter 7 Trustee will be empowered to pursue that individual for collection of the transferred funds.
Chapter 13 protects you and your loved ones.
Chapter 7 bankruptcy does only half of that.
Consequences of Voluntarily Dismissing Your Chapter 13 Bankruptcy
Most of the collections-related downsides of converting a Chapter 13 to Chapter 7 apply when the case is not converted but completely dismissed.
The difference is that these consequences materialize even faster: immediately rather than after 60 or more days of Chapter 7 processing.
Further, with a complete dismissal of a Chapter 13 bankruptcy case, there is no discharge at all.
Any debts of any sort which have not been paid in full through the Chapter 13 process will be immediately collectible in full balance and with accrued interest, late fees, and penalties the moment that the case is dismissed.
Foreclosure processes can begin or resume. Vehicle repossessions can begin or resume.
The negative consequence that does not apply when you dismiss a Chapter 13 case rather than convert to Chapter 7 is the possible liquidation of assets.
If the Chapter 13 is unsustainable for some reason and the possibility that assets may be pursued or friends or family members could be exposed to the Chapter 7 Trustee or to creditors, full dismissal may be a preferable option.
The Consequences of Dismissing or Converting a Chapter 13 Bankruptcy: The Bottom Line
The bottom line is that, if you are in a Chapter 13 bankruptcy and are experiencing hardship within the process, you should discuss any interest in dismissing the case or converting it to Chapter 7 with your Detroit bankruptcy lawyer.
It may have been quite a while since your initial consultation with your attorney, when all of the above considerations were likely discussed with you.
Refresh your memory as to why you chose Chapter 13 bankruptcy to begin with. Allow your lawyer to asset your current situation, including your current income and expenses and the current value of your assets.
Don’t make a hasty decision.
If you are considering filing for bankruptcy, contact us to schedule your initial consultation.
Attorney Walter Metzen has successfully represented Metro Detroit Chapter 7 and Chapter 13 bankruptcy clients for over 30 years.