When You Should Avoid Using Chapter 13 to Save Your Home

Chapter 13 provides awesome tools for hanging onto your home. Yet sometimes Chapter 7 is enough and better.

 

Chapter 13 and Your Home

Chapter 7—sometimes called “straight bankruptcy—is much simpler and takes much less time than Chapter 13, the version of bankruptcy with a three-to-five-year court-approved payment plan. But Chapter 13 can help in so many ways with home-related debts that people who are behind on their mortgage or have other kinds of liens on their home tend to leap to that option.

In upcoming blogs I’ll talk about all the many ways that Chapter 13 can help. But to give you a taste of them, some of the main ones include:

1. More time to catch up on any back mortgage payments: Chapter 7 gives you a limited amount of time, usually a year at the most, to catch up. Chapter 13 often gives you years, which greatly reduces how much you have to pay each month to eventually get current.

2. Stripping second or third mortgage:  Under Chapter 7 you have to simply pay any junior mortgages. Chapter 13 gives you the possibility of “stripping” a second or third mortgage lien off your home title, potentially saving you hundreds of dollars monthly, and thousands or even tens of thousands of dollars in the long run.

3. The flexibility that comes from getting extended protection from your mortgage holder(s): Chapter 7 gives you at most only about three or four months while your mortgage holder can’t foreclose and your other creditors can’t take action against you or your home. In contrast, under Chapter 13 you could potentially be protected for years. This can often give you creative ways to meet your goals, such as letting you delay selling your home for several years.

4. A good way to catch up on any back real property taxes: Filing a Chapter 7 case doesn’t protect you from property tax foreclosure—beyond the three, four months that the case lasts. Chapter 13 protects you and your home while you gradually catch up on those taxes, in a court-approved plan that also incorporates your mortgage(s) and all other debts.

5. Protects your home from previously recorded and upcoming income tax liens: Chapter 7 usually does nothing to address tax liens that have already been recorded on the home, or to stop future tax liens on income taxes that you continue to owe after the bankruptcy case is completed. In contrast Chapter 13 provides an efficient and effective procedure for valuing, paying off, and getting the release of tax liens. And the IRS/state cannot record a tax lien on income taxes while the Chapter 13 case is active.

That may all sound pretty good (and there’s more). But still, Chapter 13 may be neither necessary nor appropriate in your situation.

Consider Chapter 7 Instead of Chapter 13 When Chapter 7 is Enough

If you are behind on your mortgage payments, but could realistically catch up within about a year, you may not need the stronger medicine of Chapter 13. If you could catch up after writing off all or most of your debts in a Chapter 7 case, and by being financially very disciplined for that one year, that would likely be the wiser way to go.

Most mortgage lenders will negotiate a “forbearance agreement” with you after you file a Chapter 7 case, allowing you to stay in your home and to catch up on your mortgage arrearage by paying a certain amount extra per month. How much time you will have to get current on your mortgage depends on your lender’s practices, your payment history with that lender, and other related factors.

Considering the benefit of getting to your fresh start in a year or so, instead of three to five years, be sure to carefully discuss with your attorney whether solving your mortgage arrearage problem through Chapter 7 looks feasible. Of course also look at all the other advantages and disadvantages of these two options in light of all the rest of your financial circumstances.

Consider Chapter 7 When Chapter 13 Will Not Likely Do Enough

As powerful as Chapter 13 can be, it has its own limitations regarding home debts. For example, it does not have the ability to reduce your first mortgage payment or mortgage balance. It can’t reduce your annual property taxes or discharge (legally write off) any property taxes.  And if you subsequently cannot maintain the payments you agree to in your Chapter 13 plan, you could very well lose the protection against foreclosure and other collection efforts against you.

Especially if your home is under water—you owe on it more than it’s worth—try to think practically about whether the effort to keep the property will be worth the effort. Even if you do have some equity in the property, if you are really going way out on a limb to catch up on the mortgage arrearage and other debts related to the home, carefully consider whether you will really be able to pay what you are arranging to pay. If you pay a bunch of extra money over the course of a year or two only to not be able to maintain the necessary payments and lose the home, you could waste a lot of your time, money, and effort.

As you honestly discuss with your attorney your financial goals, consider whether filing a Chapter 7  case and letting your house go would actually be a better way to meet your (and your family’s) real needs. Chapter 13 should not be a last-ditch long-shot. Be honest with yourself that you may be trying to hang onto a house that you won’t be able to even with all the help that Chapter 13 can provide.

 

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What Happens to Most of Your Debts in Chapter 7 “Straight Bankruptcy”?

Your debts that are not secured by collateral and are not “priority” debts are discharged (written off) and paid nothing. Mostly.

 

In my blog post last week I introduced the three main categories of debts: “secured,” “priority,” and “general unsecured.”

Secured and priority debts tend to be the ones with issues worth talking about. Secured debts often have liens against your important property and possessions—your home, your car or your truck, maybe your furniture and appliances. Priority debts are ones that are usually not secured but are favored in various ways in the law. They include child and spousal support, certain taxes, and such.

It’s worth paying a lot of attention to secured and priority debts because they raise questions that are likely important to you. Such as, how does bankruptcy help you keep your car if you are behind on payments? If you file a Chapter 7 case do you have to keep paying on your furniture loan to keep your bedroom furniture, and if so how much? How can filing bankruptcy enable you to get and/or keep current on your child support? Will you be able to write off any of your overdue income taxes?

We will look into these questions and more about secured and priority debts in upcoming blog posts. And yet, you probably have more of the third category of debts, “general unsecured” ones, than either secured or priority debts. So first let’s look at what happens to your general unsecured debts, covering today what happens if you file a Chapter 7, and then in my next blog post what happens under Chapter 13.

General Unsecured Debts  

First a reminder from last week: general unsecured debts are those that don’t belong in the other two categories. They are unsecured in that they have no lien on any of your property or possessions. They are “general” simply in that they are not one of special “priority” debts that the law has selected for special favored treatment.

General unsecured debts include all sorts of obligations. Besides the most common ones like (most) credit cards and medical bills, they include personal loans without collateral, checking accounts with a negative balance, bounced checks, most payday loans, claims against you for property damage and personal injury, for breaches of contract—again, just about any way that you can owe money without collateral.

What Happens to Most General Unsecured Debts in Most Chapter 7 Cases

All these kinds of general unsecured debts are usually just legally, permanently written off—“discharged”—in a Chapter 7 bankruptcy case. That means that once they are discharged—usually about 3 months after your case is filed—the creditors can take absolutely no steps to collect those debts.

The only way those debts are paid anything is if either 1) the debt is NOT dischargeable or 2) it is paid (in part or in full) through an asset distribution in your Chapter 7 case.

 1) “Dischargeability”

A creditor can dispute your ability to get a discharge of your debt. Very few general unsecured debts are challenged and so they get discharged. In the rare case that the discharge of one of your debts is challenged, you may have to pay some or all of that particular debt. That depends on whether the creditor is able to establish that the facts fit within some quite narrow grounds. That would usually involving allegations of fraud, misrepresentation or other similar bad behavior on your part. If the creditor fails to establish the necessary grounds, the debt is discharged.

There are also some general unsecured debts that are not discharged unless you convince the court that they should be, such as student loans. The grounds for discharging student loans are quite difficult to establish.

2) Asset Distribution

If everything you own is exempt, or protected, then your Chapter 7 trustee will not take any of your assets from you. This is what usually happens—you’ll hear it referred to as a “no asset” case. But if the trustee DOES take possession of any of your assets for distribution to your creditors—an “asset case”— your “general unsecured creditors” may, but often don’t receive some of it. The trustee must first pay off any of your priority debts, as well as pay the trustee’s own fees and costs. The unsecured creditors get a pro rata share of the pool of whatever, if anything is left over.

Conclusion

In most Chapter 7 cases your general unsecured debts will all be discharged and most of the time will receive nothing from you. Rarely, a creditor may challenge the discharge of its debt. And if, again rarely, you have an “asset case,” the trustee may pay a part or—extremely rarely—all of the general unsecured debts, but only after paying all priority debts and his or her fees and costs.  

 

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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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