Interest rates are a big contributor to financial problems. A little injudicious borrowing can lead to trouble as interest balloons that initial loan or credit line to the point where it is difficult or impossible to keep up with the payments. Bankruptcy can be helpful in cases where there are multiple loans with big interest rates that are going unpaid.
Filing for bankruptcy does not mean you won’t have to still deal with some interest. It is important to understand how interest works in bankruptcy, particularly if your income is high enough that your only option is Chapter 13 bankruptcy.
When filing Chapter 13, you are essentially agreeing to a proposed payment plan to repay all or part of your debts. Unlike Chapter 7, where most of your debt is discharged, in Chapter 13 you will still owe a big chunk of your debt that will still have to be paid off. Additionally, you will owe interest on that debt.
It is likely that the interest rate will be lower than your contracted rate, however. In Chapter 13, the court applies a standard interest rate for your debt. This standard rate is the Wall Street Journal prime rate, plus 1.5%. It changes on June and December 1st. On June 1st, 2015, it was set at 4.75%.
This rate will be in effect for the whole of the bankruptcy payment plan. When filing Chapter 13, you must submit a plan that is in effect for at least 3 years and not less than 5 years. The interest rate that applies can be changed upon application to the court on behalf of the debtor or creditors, but usually it is the standard rate.
Whatever the interest rate ends up being, it will not be applied equally to all of your debt. Debt is divided into different types, and whether or not interest rates apply to a particular debt depends on what type it is, and how you plan to repay it.
This is debt that has been secured with some sort of collateral. Mortgages and car loans are both types of secured debt. Unlike in Chapter 7, under Chapter 13 you have the option of keeping the assets that are securing the debt. However, you will have to pay off the debt in full in that case.
That debt will usually have to be paid off within the bankruptcy payment plan, and over that time period, it will be subject to the interest rate agreed upon during bankruptcy proceedings. The exception to this rule is when the secured debt qualifies as an ongoing debt.
Ongoing debt is a loan that was originally structured with an end date beyond the end of the bankruptcy payment plan. Mortgages that extend for several years beyond the five year limit of the payment plan are common. Car loans might also potentially be ongoing debt.
Ongoing debt will be charged the rate agreed upon in bankruptcy proceedings for the length of the payment plan. The interest rate that applies after the payment plan ends is a detail that should be worked out with the help of your lawyer.
Second mortgages and car loans have special rules that apply to them in the event that you are upside down on your loan. This means that you owe more than the collateral (your home or car) is worth. In this case, the debt up to the value of the collateral is considered secured debt. Anything owed above that value becomes unsecured debt.
Property taxes may also be considered secured debt, with the same rules applying.
Unsecured Priority Claims
Debt that is not secured with collateral is called, unsurprisingly, an unsecured claim. Some unsecured claims are determined by the court to be priority claims, meaning they have to be paid in full. This includes debt like child or spousal support, as well as court and attorney’s fees. This debt does accrue interest at the rate established during bankruptcy proceedings.
General Unsecured Claims
These are all the other debts that you owe. This can include credit card debt, payday loans, medical bills, utilities, and anything else. You will have to pay interest on what it is determined you owe to these creditors. However, most people generally pay only a small percentage of these debts back.
The details of how bankruptcy works can be confusing. There are different kinds, and how you qualify for each of them is not always clear. It involves lawyers and courts, which is always stressful and frightening. People are frequently hesitant to investigate or even think about bankruptcy.
Bankruptcy does not mean an end to your financial life, however. It is intended as a way for people who are in over their heads to get a fresh start, and the courts and lawyers involved are usually interested in mediating a bad situation so that everyone has the best result possible.