When a Chapter 7 “Straight Bankruptcy” Helps You Enough on Your Home

A 3-to-5-year Chapter 13 case is often the right tool if you are behind on mortgage payments. But sometimes the simpler Chapter 7 is enough.

 

Chapter 13 Is a Powerful Package

If you want to keep your home but are behind on your mortgage payments, a Chapter 13 “adjustment of debts” is often what you need. It comes with an impressive set of tools to address many home debt problems. It gives you more time to catch up on the mortgage, may enable you to “strip” a second or third mortgage off your title, and gives you very helpful ways for dealing with property taxes, income tax liens, judgment liens, and such.

When Chapter 7 is Enough  

But what if you have managed to fall only a few months behind on your mortgage, and could afford the payments if you just got relief from your other debts?

Or what if you aren’t even keeping the house, but do need a little more time to find another place to live?

Then you may not need a Chapter 13 case, and could save the extra time and cost that it would take compared to Chapter 7. In the right situations Chapter 13 is highly worthwhile because of what it can do. But if you don’t need those advantages, Chapter 7 may be adequate and appropriate.

Buying Just Enough Time for What You Need

The “automatic stay”—the bankruptcy provision that stops virtually all actions by creditors against you or your property—applies to Chapter 7 just as it does to Chapter 13.  So the filing of a Chapter 7 case stops a foreclosure just as quickly as a Chapter 13 filing.

But Chapter 7 usually buys you much less time than a Chapter 13 could.

If you are not very far behind on your mortgage payment(s) and want to keep your home, when you file a Chapter 7 case your mortgage lenders will usually give you several months to catch up on your back payments. You must immediately start making your regular monthly payments, if you had not been making them, and must enter a strict schedule for catching up on the arrearage. In return the lender agrees to hold off foreclosing, as long as you make the payments as agreed.

If instead you are not keeping the house but just need to have more time to save money for moving into a rental home, a well-timed Chapter 7 case will buy you more time in your house. During that time you don’t pay mortgage payments, enabling you to get together first and last month’s rent payment, any necessary security deposit and other moving costs.

The tough-to-answer question is how much extra time would a Chapter 7 filing give you. It mostly depends on how aggressive your mortgage company is about trying to start or restart the foreclosure efforts.  A pushy lender could, soon after you file your case, ask the bankruptcy court for “relief from the stay”—permission to start or restart the foreclosure process. If so, then your bankruptcy filing would buy you only an extra month or so.

Or on the other extreme, a mortgage lender could potentially take no action during the 3 months or so until your Chapter 7 case is finished. At that point the “automatic stay” protection expires, and the lender can start or restart the foreclosure. Or it may sit on its hands even longer. During the height of the mortgage crisis a few years ago, mortgage lenders were so backed up and so reluctant to foreclose, that many homeowners were living in their homes without making payments for a year or two! That is mostly a thing of the past but it goes to show how open-ended this situation can be at times.

Your bankruptcy attorney will likely have some experience in how aggressive your particular mortgage lender is under facts similar to yours.

Stopping Dangerous Liens Against Your Home

Chapter 7 prevents potential liens from being placed against your home, especially important when the lack of a lien makes all the difference. This can occur with IRS and state tax liens and judgment liens. A timely filing of a Chapter 7 case could result in paying nothing on a debt vs. paying it in part or in full.

Consider the example of an older IRS debt that meets the conditions for discharge (legal write-off in bankruptcy), in a situation in which you have equity in your home but no more than would be protected under the homestead exemption. If you did not file a bankruptcy until after the IRS recorded a tax lien for that debt against your house, that lien would continue being attached to your house in spite of your bankruptcy. You would have to pay the tax debt in order to get the lien released when you sold or refinanced the house.

However, if your Chapter 7 case was instead filed before the IRS recorded a tax lien, the “automatic stay” would prevent that tax lien from being recorded, the tax debt would be discharged and never have to be paid.

Discharge Other Debts So You Can Afford to Pay Your Mortgage Payments

Chapter 7 allows you to focus your financial resources on your house payments by getting rid of your other debts.

If you’ve managed to keep current on those mortgage payments, but fear you can’t continue to do so because of financial pressure from other debts, the relief you get from discharging those other debts can allow you to stay in your home long term.

Or you may have missed only a few mortgage payments, AND, after discharging your other debts, can reliably make future monthly payments plus enough extra to catch up on your arrearage within year or less. If so, then Chapter 7 would like likely do enough for you. Most mortgage creditors will make arrangements with you –called a “forbearance agreement”—to catch up the missed payments by paying a sufficient specific amount extra each month until you’re caught up, as long as that catch-up time is relatively short.

However, if after discharging your other debts you could not catch up on your arrearage within about a year, you may well need the extra firepower of Chapter 13 to buy you more time.

 

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Are These Sensible Reasons to Do A Short Sale? Maybe, Maybe Not

Let’s look at some commonsensical reasons to do a short sale of your home and see if they make sense.

 

My last blog post showed how a short sale may be harder to achieve than you might think, and how they can be dangerous if you do it without advice from an attorney looking out for you.

So today we follow up by looking more closely at why you would do a short sale. Besides probably the most common one of simply trying to avoid the bad credit of a foreclosure, which we addressed last time, here are some other common reasons:

1. No Choice, Can’t Afford the House

If your income has gone down or your mortgage payments have gone up so that you can’t keep making the payments, it may make sense to downsize—sell your home and rent. And if you can’t sell your home because it’s worth less than the mortgage balances, then a short sale may seem to be the only way to leave the home and its debt behind.

However…

Monthly rental payments have climbed significantly in the last several years as more people have lost their homes to foreclosures, and less young people have been able to afford or qualify for a mortgage because of the tough employment market and skyrocketing student loan debt.  Demand has outstripped the supply of rental housing in many markets, greatly increasing the cost to rent.

Also, you have many legitimate tangible and intangible reasons to stay in your home. If you leave this home it may be a long time before you would have the financial means to buy again, especially with the tighter credit standards that are likely to be in place for years. Property values in many parts of the country have gone up significantly in the last year or two and seem to be on a trajectory to continue doing so. So you may be building equity in your home soon. And your family may benefit from staying in your home for deep personal reasons—to maintain family stability, to avoid leaving your kids’ school district, and such.

So if there would be a way that you would be able to afford your home, that way would be worth considering carefully.  

2.  Can’t Reduce House Mortgage Payments, Right?

It’s true that you are largely stuck with whatever your monthly first mortgage payment amount is. And if you are behind on those payments, you will have to catch up if you want to keep your home.

However…

If you have a second (or third) mortgage, you may be able to “strip” that mortgage off your home’s title so that you would not need to make that mortgage’s monthly payments. This can happen under a Chapter 13 “adjustment of debts” if your home is worth less than the balance of your first mortgage, so that there is no equity at all in your home for the second mortgage.

By “stripping” this second mortgage from your home, your debt on that mortgage debt would be treated as an unsecured debt, just like all of the rest of your conventional unsecured debts (credit cards, medical bills and such). This means you would pay that mortgage debt during your 3-to-5 year Chapter 13 case as much, but only as much, as you could afford to pay on it, which is often not much—sometimes even nothing. Then at the end of the case, whatever has not been paid by then is discharged–legally written off completely.

As a result you avoid having to pay the monthly second mortgage payments, and the debt against your home is significantly reduced. These—along with the other benefits of Chapter 13—can potentially make hanging onto your home both financially feasible in the short term and financially much more sensible in the long term. You would pay less each month for a home with much less debt on it.

3.  Needing to Resolve Other Liens

You may feel compelled to do a short sale not just because of your mortgage obligations, but because of one or more other obligations which have attached to your home’s title, with a tax, judgment, support, utility, or construction lien.

You may be under a great deal of pressure to pay one or more of these obligations. The IRS, state tax, and child support enforcement agencies can be especially aggressive. So you could understandably feel that you have no choice but to sell your home to get that aggressive creditor paid, and to sell by short sale if necessary.

The problem is that the more lienholders you have, the more creditors must be corralled into accepting less than their full balance in return for releasing their lien on your home. And even if the special lienholder releases its lien for less than full payment so that the short sale succeeds, you will continue owing the balance, and likely continue being pursued for payment.

However…

Either Chapter 7 or Chapter 13 bankruptcy can often deal well with each of these kinds of lienholders. Both may be able to “void” judgment liens. Chapter 13 is particularly adept at attacking tax and support liens and their underlying debts. Furthermore, you can be protected for years from any further collection efforts by these otherwise very powerful creditors, in ways that no other legal procedure could accomplish.

Conclusion

Bankruptcy options often give you more control over your home and over your financial life than would occur through a short sale. Given what’s at stake, it certainly makes sense to consult an attorney about your options. Your attorney is on your side, legally and ethically bound to explain all your options as they relate to your personal goals and your best interests.

 

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Short Sales of Your Home–Sometimes Necessary, Often End Not As You Expected

A short sale might be your best alternative. But they can be hard sales to close, and may not accomplish what you hope.

 

Someone Doesn’t Get Paid

In a short sale, you sell your house by “shorting”—underpaying—one or more of the lienholders, because the sale price is not enough to pay everyone in full.

In the depths of the recent real estate crash, a large percentage of home sales were short sales because the value of so many houses had fallen below what was owed on them. Even though property values have climbed in many parts of the country, there are still millions of homes “under water,” and so can only be sold in a short sale.

Why Short Sales Are Harder to Close

You can imagine that if a mortgage holder or someone else has a lien on your home and a legal right to be paid in full, it will be reluctant to take anything less than payment in full before releasing its lien. And these lienholders can include not just voluntary ones like your first and maybe second mortgage, but also judgments, income taxes, support obligations, unpaid utilities, and property taxes. Generally all lienholders must consent and release their liens, or the sale cannot occur.

Their Benefits

Beyond getting out of a house that you can’t afford, the main benefit of a successful short sale is that it avoids a foreclosure on your credit record. Although in general that is a sensible goal, a short sale is also likely detrimental on your credit record—after all you are not paying one or more of your creditors in full. Also, given how many millions of foreclosures occurred in the last 5-6 years, there is some indication that there is and will continue to be less credit record difference between a short sale and a foreclosure. Depending on the rest of your credit record, now and in the future, focusing on avoiding foreclosure may not be as important as you may think.=

Short Sales Often Do Not Come Together

Most short sales take much more effort and time to pull off than expected, so they usually take longer, and then often fail to close, putting the homeowners further behind and no better off. The reasons they often don’t work are:

  • Unhelpful and slow mortgage lenders: In a short sale usually the first mortgage holder has to give some money from the sale proceeds to a junior lienholder or two. The only reason the first mortgage holder would do that is if getting a little less out of the sale is better than going through the delay and cost of a foreclosure. Although many mortgage lenders have gotten better organized and staffed to process short sales, working with them can still be like pulling teeth.
  • Any lienholders can refuse to cooperate and kill the deal: When the pie that is too small, it’s hard to make everybody happy and cooperative. Any lienholder can refuse to take the proposed reduction in payment and jeopardize the closing.
  • The realtors and other middlemen often have the most to gain: Realtors and others in the real estate sales industry often benefit more from a short sale than you do. There are good reasons that unbiased observers—like bankruptcy judges—tend to discourage short sales.

Short Sales Can Be Dangerous

You could end up legally liable to those lienholders who were not paid in full, and could also potentially owe extra income taxes.

  • Unpaid balances on the junior mortgages and liens: You may be told that you will not be liable on debts that aren’t paid in full from the home sale, but that’s not always true. You need to be sure that the settlement documents and the applicable law in fact cut off any liability. Be careful about feeling forced to accept some remaining liability just to get the deal done.  
  • Potential tax consequences: This issue is a complicated one that can’t be covered here in adequate detail. The main point is that debt forgiveness can be treated as income subject to taxation unless you fit within one of the exceptions. Make sure you talk with an appropriate tax specialist about this before investing any time or expectations in the short sale option.  

Short sale attempts often fit two wise rules of thumb: 1) desperate actions often lead to no good, and 2) if it sounds too good to be true, it probably is.

 

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If You File a Chapter 7 Bankruptcy with an Attorney You are Nearly Ten Times More Likely to Reach Your Goal of Writing Off Your Debts

Here’s some hard evidence on why it’s dangerous to file bankruptcy without an attorney.

 

As a bankruptcy attorney, I get many phone calls from people who have tried to file a bankruptcy by themselves and have gotten into trouble, sometimes serious trouble. I also run into similar horror stories about what happens when people file without an attorney when I attend “meetings of creditors”—the usually straightforward, usually short meeting with the bankruptcy trustee that everyone filing bankruptcy must attend. I’ve run into countless example of how dangerous it is to file bankruptcy without an attorney.

But I HAVE wondered whether anybody has actually investigated this question. Now somebody has, and we have some pretty solid evidence to back up what I have been witnessing anecdotally.

“The Do-It-Yourself Mirage: Complexity in the Bankruptcy System”

That is the title to a chapter in a book about bankruptcy called Broke: How Debt Bankrupts the Middle Class. This book is a series of articles about many important current issues in the field, with this one chapter focusing on cases filed by debtors not represented by attorneys (“pro se” filers).

The author of this chapter, Asst. Professor Angela K. Littwin of the University of Texas School of Law, analyzed data from the Consumer Bankruptcy Project, “the leading [ongoing] national study of consumer bankruptcy for nearly 30 years.” Her finding: “pro se filers were significantly more likely to have their cases dismissed than their represented counterparts.”

Very interestingly, she also learned from the data that

consumers with more education were significantly more likely than others to try filing for bankruptcy on their own, but that their education didn’t appear to help them navigate the process. Pro se debtors with college degrees fared no better than those who had never set foot inside a college classroom.

She concluded that after bankruptcy law was significantly amended back in 2005 in an effort to discourage as many people from filing, “bankruptcy has become so complex that even the most potentially sophisticated consumers are unable to file correctly.”

Ten Times More Likely to Get a Discharge of Your Debts

In a closely related study, Prof. Littwin stated that “17.6 percent of unrepresented [Chapter 7 “straight bankruptcy”] debtors had their cases dismissed or converted” into 3-to-5-year Chapter 13 “adjustment of debts” cases.  “In contrast, only 1.9 percent of debtors with lawyers met this fate.”  Even after controlling for other factors such as “education, race and ethnicity, income, age, homeownership, prior bankruptcy, whether the debtor had any nonminimal unencumbered assets at the time of the filing,” “represented debtors were almost ten times more likely to receive a discharge than their pro se counterparts.”

Prof. Littwin concluded that “filing pro se dramatically escalates the chance that a Chapter 7 bankruptcy will not provide a person with debt relief.”

 

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