What it means
The person files a plan with the bankruptcy court that shows how much they will pay each month, how long the plan will last and how the money will be divided among creditors. The payments are made to a trustee, an official who collects the money and distributes it according to the plan.
Creditors are paid in a legal order. Secured creditors such as mortgage lenders are usually paid in full on arrears (overdue amounts), priority debts such as certain taxes and support obligations come next, and general unsecured creditors, such as credit card issuers, share what remains.
A key test is that unsecured creditors must receive at least as much as they would have received if the person's assets had been sold under a liquidation. The person must also commit all of their disposable income, which is income after reasonable living costs, for the length of the plan.
Once the case is filed, an automatic stay stops most collection action, including lawsuits, wage garnishment and foreclosure, while the plan is considered. That breathing space is a main reason people choose this route to save a home that is behind on mortgage payments.
Failing to make payments can lead to the case being dismissed, which would bring back the creditors' rights. Completing the plan does not always repay creditors in full, and a bankruptcy case remains on a credit record for years.
The court looks at the budget in detail before approving a plan. It reviews income, living costs and the proposed payments, and it may reject a plan that is too optimistic or that pays certain creditors more than the law allows.
In practice
Real-world examples.
Example
A teacher falls three months behind on her mortgage after a medical emergency. She files a plan that pays the arrears over 48 months while keeping up the regular payments. The lender cannot foreclose as long as she follows the plan.
Example
A self-employed electrician with steady income owes $60,000 on credit cards and a tax bill. He proposes a five-year plan that pays the tax bill in full and a portion of the card debt. Remaining eligible card debt is discharged at the end.
Example
A couple with a car loan larger than the car's value uses the plan to reduce the secured claim to the car's value. The remaining balance is treated as unsecured and receives only a share of the plan funds.
Formula
Calculation
Total plan payments = Monthly payment x Number of months
Percentage paid to unsecured creditors = Funds available for unsecured creditors / Total unsecured claims
A debtor proposes a payment of $700 a month for 60 months. Total plan payments = 700 x 60 = $42,000. Assume the trustee's fee is 10%, which is 42,000 x 10% = $4,200, leaving 42,000 - 4,200 = $37,800. The plan must pay $12,000 of priority debts and $9,000 of mortgage arrears, which total 12,000 + 9,000 = $21,000. Funds available for unsecured creditors = 37,800 - 21,000 = $16,800. If total unsecured claims are $84,000, the percentage paid = 16,800 / 84,000 = 20%.Case study
Seen in the real world.
Elmwood Family Dental is an illustrative, fictional small practice whose owner, a dentist, also had personal guarantees on business debts. After a year of lower income she fell behind on her home loan and credit cards.
Her advisers helped her file a plan of $1,400 a month for 60 months, which was 1,400 x 60 = $84,000 in total. After a 10% trustee fee of $8,400, there was $75,600 to distribute, of which $30,000 went to mortgage arrears and priority taxes.
In the illustrative outcome, the remaining 75,600 - 30,000 = $45,600 was divided among unsecured creditors. She kept her home and practice, and her unsecured debts were discharged on completion of the plan.
Watch out
Common mistakes.
- Assuming the plan wipes out all debts, when priority debts and secured arrears usually must be paid in full.
- Missing payments to the trustee, which can lead to dismissal and loss of the protection of the automatic stay.
- Ignoring ongoing living costs and new debts, because the plan assumes the person can keep up with regular obligations while paying the trustee.
Questions
People also ask.
Who is eligible for a wage earner plan?
An individual with regular income whose debts are within the legal limits can apply, and the limits are set by law and adjusted from time to time.
How long does a plan last?
Usually three to five years, depending on the person's income and the debts to be repaid.
What happens at the end of the plan?
If all payments are made, the court normally grants a discharge of the remaining eligible unsecured debts.
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