A Combination of Chapter 13 Tools for Saving Your Home, Illustrated

It’s often the combination of tools that come with Chapter 13 that allows you to keep your home. Because Chapter 7 has only some of these tools, sometimes it can’t do nearly as much for your home as Chapter 13 can.

 

Please read my last blog. There I laid out an example to illustrate how much a Chapter 13 case can do—on multiple fronts—to enable you to keep your home. That example also shows why sometimes Chapter 7 is not effective for that purpose. Today I explain how Chapter 13 can pull it off.

To summarize, here is a list of this hypothetical person’s debts:

• first mortgage arrears: $5,000
• first mortgage balance: $230,000
• second mortgage arrears: $3,000
• second mortgage balance: $50,000
• past-due real estate taxes: $2,000
• judgment lien from unpaid medical debt: $8,000
• 2009 income tax with tax lien recorded against the home: $3,000
• 2010 and 2011 income tax: $5,000 (no tax lien, yet)
• credit cards: $18,000

A Chapter 7 “straight bankruptcy” would discharge (write-off) all or most of the credit card balances, as well as the medical bill that turned into the judgment, and likely even get rid of that judgment’s lien on your home title. That would save you about $26,000, and take away the threat to your home from the judgment lien.

But that still leaves both mortgage arrears, the past due real estate taxes, and many thousands of dollars of income tax debts, one holding a tax lien on the home. This debtor can afford to pay a total of $1,500 per month to all creditors, but with a $1,000 first mortgage and $300 second mortgage regular payment, that leaves only a measly $200 per month for the mortgage arrearages and all the taxes. Looks quite hopeless.

And yet, here is how Chapter 13 could be the solution:

1. Stripping second mortgage: In this example the home is now worth $225,000, less than the $230,000 balance on the first mortgage. So there is no equity in the home securing that second mortgage. Under these conditions, Chapter 13 can legally turn that second mortgage balance into an unsecured debt. (This cannot be done under Chapter 7). As a result, the debtor no longer pays the $300 monthly mortgage payment, freeing up that amount to pay other more important creditors. So instead of $200, there’s now $500 per month available to pay the remaining creditors.

2. Plan payment of $500 per month: Paying this $500 per month into a 36-month Chapter 13 payment plan results in a total of $18,000 paid ($500 X 36 = $18,000), or a total of $30,000 in a 60-month plan ($500 X 60 = $30,000). The length of a plan depends on a number of factors. But in this case let’s assume that the plan will run only as long as it takes to pay all secured and priority creditors—here, the first mortgage arrears and all the property and income taxes. That’s $5,000 of arrears, $2,000 of property tax, $8,000 for all the income taxes, or a total of $15,000. Interest needs to be paid on the property tax and on the portion of the income taxes with the tax lien, but Chapter 13 often allows those debts to be paid faster to lessen the amount of interest. The plan payments also need to pay the Chapter 13 trustee-- usually a percentage of the amount flowing through the plan--plus whatever portion of the debtor’s own attorney’s fees not paid before the filing of the case. To simplify the calculations, let’s estimate that the total amount that the debtor would need to pay into the plan would be $20,000. At $500 per month, that would amount to 40 months of payments. (In some situations, the unsecured creditors would also need to be paid a certain amount of money or a certain percentage of their debt. In that situation, the $500 payments would need to be paid into the plan that much longer.)

3. Continuous protection from the creditors by the “automatic stay’: During the entire length of the Chapter 13 case—this estimated 40 months--the “automatic stay” would be in effect, preventing any of the creditors—the mortgage lenders, the property tax creditor, or the IRS—from taking any action against the debtor or the debtor’s home. So the first mortgage lender would not be able to start or continue a foreclosure because the monthly payments or the property taxes weren’t current. The property tax creditor itself could not conduct a tax foreclosure. And the IRS could not enforce its tax lien nor could it record a new one for the more recent tax debts.

4. Debt-free: At the end of the 40 months or so, the first mortgage and property taxes would be paid current, all of the income taxes would be paid in full, the tax lien would be released, and all the (remaining) unsecured debts would be discharged, leaving the debtor debt-free.  

The Power of Chapter 13 to Save Your Home, Brought to Life

A mere list of the many ways that Chapter 13 can help save a home can start sounding dry. So here’s a powerful example that shows off some of its extraordinary advantages.

 

Let’s start by setting the scene. Say you lost your job in early 2010 and, except for temporary, part-time work, you did not find new full-time employment until 3 months ago. It pays less than your old job.

• While you weren’t working full-time, you used up your savings and then borrowed on your credit cards to try to pay the house payments. That seemed to make sense at the time because you kept getting promising job leads, none of which panned out until you finally got hired for your present job. So you owe $18,000 on the credit cards, with minimum payments totaling $550 per month.
• After your savings and available credit ran out, you still fell $5,000 behind on your first mortgage and $3,000 behind on your second. They are both starting to send papers sounding like they are going to start foreclosing.
• Because there wasn’t enough money in your property tax escrow account with your first mortgage lender to pay the recently due annual $2,000 property tax bill, the lender is demanding that you pay that right away. It is threatening to foreclose for this separate reason if you don’t.
• You had some medical problems soon after losing your earlier job, while you had no medical insurance, resulting in a $7,500 medical bill. That went to a collection agency, turned into a lawsuit, and then recently into an $8,000 judgment lien against your home.
• Money had been tight even back before you’d lost your job because of cutbacks in hours, so you cut your tax withholding way back, so that you owed $2,000 to the IRS for 2009 income taxes. You couldn’t make the agreed monthly installment payments, and have just found out that that a tax lien has been recorded against your home in the amount of $3,000, after adding in all the accrued penalties and interest.
• While you were working temporary jobs during 2010 and 2011, you were desperate for every dollar you could bring home, and so didn’t have any taxes withheld. As a result you owe the IRS another $2,500 for each year, or a total of another $5,000 that you have not even filed tax returns for yet.  You’re afraid to because you have no money to pay it and are afraid of more tax liens against your home.
• Your home was worth $300,000 in 2008, but has lost about 25% of its value by now, so is worth $225,000. You owe $230,000 on the first mortgage, with monthly payments of $1,000, and owe $50,000 on the second mortgage, with monthly payments of $300.
• With your current reliable income, after paying modest but reasonable living expenses, you have $1,500 available monthly for all creditors, including the two mortgages. That’s only $200 per month beyond the two mortgage payments, a drop in the bucket considering this mountain of debt:
  
  • credit cards: $18,000
  • first mortgage arrears: $5,000
  • second mortgage arrears: $3,000
  • property tax arrears: $2,000
  • judgment lien: $8,000
  • 2009 income tax with tax lien: $3,000
  • 2010 and 2011 income tax: $5,000

That’s a total debt of $44,000, besides the $230,000 first mortgage and $50,000 second mortgage.

• Last fact: your two school-age kids live with you, they’ve lived in this home their whole lives, and have gone to the good local public schools for years, with their friends who live in the neighborhood. So more than anything you want to maintain this home and the stability it brings to their lives (and yours!). But it sure seems hopeless.

A Chapter 7 “straight bankruptcy” would help by discharging (writing off) tens of thousands of dollars, but NOT likely help nearly enough for you to be able to keep the home. A Chapter 7 case would likely discharge all or most of the credit card balances, as well as the medical bill that turned into the judgment, and likely even get rid of that judgment’s lien on your home title. That would save you about $26,000, and take away one threat to your home. But with only $200 to spare after paying the current first and second mortgage payments, that $200 is just way too small to even begin to satisfy the mortgage lenders or the IRS, much less both.

So after your Chapter 7 case would be completed, the IRS would attempt to collect the 2009 debt through garnishments of your bank account or wages, and sooner or later you’d have to deal with the 2010 and 2011 taxes, possibly resulting in them at some point turning into tax liens. And sooner or later your home would be foreclosed because you would have no way to catch up on the mortgage arrears.

However, if INSTEAD you filed a Chapter 13 case, under these circumstances you very likely you WOULD be able to keep your home, cure the mortgage arrears, and pay off all the taxes. And all this would happen while you and your home was protected from collection efforts by any of your creditors. How could that possibly be? I’ll show you in my very next blog. Sorry to keep you hanging, but today’s blog is way too long already.

Debts with Collateral--THE Fixation of Many Bankruptcies

Your vehicle loan, home mortgage, account at the appliance or electronics store, and maybe a debt that’s resulted in a judgment lien—these debts with collateral are the ones that grab the most attention during a bankruptcy case. And that includes the attention of the creditors, very interested in “their” collateral.

 

General unsecured debts, which I talked about in the last two blogs, are pleasantly boring in most bankruptcy cases. In a Chapter 7 case, they are generally discharged (legally written off) without any opposition by the creditors, who usually get nothing. And in a Chapter 13 case, general unsecured debts are often just paid whatever money is left over after the secured and priority debts, and trustee and attorney fees, are paid. Nice and boring. That’s because the creditors don’t have much to fight about.

But with secured debts—debts with collateral—both sides have something to fight about—the collateral. The creditors know that the vehicle or house or other collateral is the only thing backing up the debt you owe to them, so they can get quite pushy about protecting that collateral.

The next few blogs will be about how you use either Chapter 7 or Chapter 13 to deal with the most important kinds of secured debts. Today we start with a few basic points that apply to just about all secured debts.

Two Deals in One

It helps to look at any secured debt as two interrelated agreements between you and the creditor. First, the creditor agreed to give you money or credit in return for your promise to repay it on certain terms. Second, you received rights to—and usually title in—the collateral, with you in return agreeing that the creditor can take that collateral if you don’t comply with your first agreement to repay the money.

Generally, bankruptcy will absolve you of that first agreement—your promise to pay—but the creditors’ rights to collateral survive bankruptcy (except in certain rare situations we will highlight later). Your ability to discharge the debt gives you some options, and can sometimes give you a certain amount of leverage. But the creditors’ rights about the collateral give them certain options and leverage, too. You’ll see how this tug-of-war plays out with vehicle and home loans, and few other important secured debts.

Value of Collateral

In that tug-of-war between your power to discharge the debt and a creditor’s rights to the collateral, how much the collateral is worth as compared to the amount of the debt becomes very important. If the collateral is worth a lot more than the amount of the debt, the creditor is said to be well-secured. It has a much better chance of having the debt be paid in full. You’ll really want to pay off the relatively small debt to get the relatively expensive collateral free and clear of that debt. Or if you didn’t make the payments the creditor will get the collateral and sell it for at least as much as the debt.

If the collateral is worth less than the amount of the debt, the creditor is said to be undersecured. It is much less likely to have this debt paid in full. You’ll be less likely to pay a debt only to get collateral worth less than what you’re paying. And if you surrender the collateral the creditor will sell it for less than the debt amount.

Depreciation of Collateral, and Interest

With the value of the collateral being such an important consideration, the loss of value through depreciation is something that creditors care about, a concern which the bankruptcy court respects. Also, in most situations secured creditors are entitled to interest. So, you’ll see that in fights with secured creditors, this issue about the combined amount of monthly depreciation and interest often comes into play.

Insurance

Virtually every agreement with a secured creditor—certainly those involving vehicles and homes—requires that you carry insurance on the collateral. If the collateral is damaged or destroyed, this insurance usually pays the debt on the collateral before it pays you anything. And, if you fail to get the required insurance—or sometimes even if you simply don’t inform the creditor about having the insurance—the creditor itself is entitled to buy “force-placed” insurance to protect only its interest in the collateral, AND charge you the often outrageously high premium.

 

With these points in mind, the next blog will tell you your options with your vehicle loan under Chapter 7.