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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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Another Five Tremendous Tools to Save Your Home through Chapter 13

These additional 5 tools, especially in combination, can tackle and defeat your mortgage and other home-debt problems.

 

 In my last blog post, I gave you five huge ways that Chapter 13 can save your home. I’ll summarize those briefly here, and then give you and explain another five of them.

Here are the first five. Under Chapter 13 you can:

1. … stretch out payments for catching up on back mortgage payments, as much as five years.

2.   … cur or erase your other debt obligations so that you can afford your mortgage payments.

3. … prevent income tax liens, child and spousal support liens, and judgment liens from every attaching to your home.

4. … pay the debts that cannot be discharged (legally written off) in bankruptcy while being protected from those creditors putting liens on or enforcing liens against your home.

5. … get rid of debts owed to creditors which could otherwise put and enforce liens on your home.

And here are today’s additional five Chapter 13 benefits for your home:

6. … avoid paying all or some of your second (or third) mortgage.

This is the powerful “mortgage strip” that can save you hundreds of dollars a month and sometimes many tens of thousands of dollars over the time you live in your home.

If—and only if—the value of your home is no more than the balance of your first mortgage, your second mortgage can be treated as an unsecured creditor. If so, you can “strip” that second mortgage off the title of your home. This means you can stop making the monthly payments on it. The entire amount that you owe is added to your pool of other unsecured creditors, which are all paid only as much as you can afford to pay over the life of your three-to-five-year Chapter 13 case. And then at the end of the case whatever has not been paid is completely discharged at the end of the case.

Although property values have increased in the last couple of years, there are still millions of homes “under water”—owing more debt than they are worth—and many of these are worth less than their first mortgage.  If this applies to you, it may be reason enough to do a Chapter 13 case. You can usually end up paying only pennies on the dollar—or sometimes even nothing—on your second (or third) mortgage. This leaves your home both much easier to hang on to and much closer to not being “under water.”

7. … get more time to pay property tax arrearage, while protecting your home from both tax and mortgage foreclosure.

If you have fallen behind on your property taxes, this creates two problems. First, you risk losing your home to a property tax foreclosure by the county or whatever other governmental entity is collecting the tax. Second, since your mortgage lender requires you to keep current on your property taxes and considers you falling behind as an independent violation of your mortgage agreement, this gives your lender a separate reason for IT to foreclose on your home.

So Chapter 13 gives you time to catch on your property taxes while both protecting you from the property taxing entity itself and preventing your mortgage lender from using your unpaid property taxes as a separate reason for foreclosing on your home.

8. … prioritize paying many home-related debts—such as property taxes, support liens, utility and construction liens—that you need to and often wish you were able to pay.

Neither Chapter 7 nor Chapter 13 enables you to simply get rid of these special kinds of liens on your home. But Chapter 13 allows—indeed often requires—you to pay them in full ahead of most of your other creditors. This often benefits you because it allows you to focus your limited financial resources on paying those debts which will preserve and add equity to your home.

9. … get rid of judgment liens, so that they no longer attach to your home.  

If a creditor sues you and you don’t respond by the deadline to do so, the creditor will get a judgment—a court determination that you owe whatever the creditor’s lawsuit says you owe. Most of the time that judgment creates a judgment lien against your home. Depending on a number of factors like the value of your home, the amount of your mortgage(s) and other liens, the amount of the judgment lien, and the amount of the homestead exemption that you are entitled to, bankruptcy will allow you to “void”—get rid of—that judgment lien. This is very important because otherwise even if the underlying debt is discharged, the judgment lien would survive the bankruptcy, causing you to still have to pay the debt eventually, in part or in full.   

If you qualify for judgment lien “avoidance” it can also be done under a Chapter 7 case, but it is often better in a Chapter 13 case when used in combination with these other tools.

10. .. sell your house without the pressure of a foreclosure sale, either just a short time after filing the Chapter 13 case, or sometimes even three, four years later.

If you are close to selling your home, or have just started the process but want to sell as soon as you can, Chapter 7 usually buys you very little time in avoiding a pending foreclosure. It gives you very little leverage or flexibility. In these situations, Chapter 13 will usually buy you more time to sell while preventing foreclosure. And, especially if you have some equity in your home, it will give you more payment flexibility.

Or if you want to sell your home a few years from now, Chapter 13 can give you some very valuable flexibility in catching up on a mortgage arrearage. You may be planning on downsizing once your children finish high school or you reach some other important life event. Or you may want to wait until property values increase over the next couple years. Under Chapter 13 you can often put off catching up on some or all of your mortgage arrearage until that anticipated sale date, making it more financially feasible to keep your home in the meantime.

 

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Five Tremendous Tools to Save Your Home through Chapter 13

Powerful Chapter 13 gives you tools to solve your mortgage and other home lien problems from a number of different angles. 

 

The Limits of Chapter 7 “Straight Bankruptcy”

In my last blog I described how a Chapter 7 case can under certain circumstances help you enough to save your home. Or in other situations it can at least help you delay a foreclosure for as long as you need.  But Chapter 7 can only give limited help, maybe enough if you aren’t too far behind on your mortgage circumstances, or you don’t have other kinds of lienholders causing problems.

The Extraordinary Tools of Chapter 13

Chapter 13, on the other hand, provides you a range of much more powerful and flexible tools for solving many, many debt issues so that you can keep your home.

Here are the first five of ten significant ways that Chapter 13 can save your home (with the other five to come in my next blog).

Under Chapter 13 case you can:

1.  stretch out the amount of time for catching up on back mortgage payments for as long as 5 years. This is in contrast to the one year or so that most mortgage lenders will give you to catch up if you do a Chapter 7 case instead. This longer period can greatly lower your monthly catch-up payments, making more likely that you would succeed in actually catching up and keeping your home. Very importantly, throughout this catch-up period your home is protected from foreclosure as long as you stay with the payment plan, one that you propose. Within limits you can later modify that plan if your circumstances change.

2. slash your other debt obligations so that you can afford your mortgage payments. The mortgage debt—especially your first mortgage—can’t be significantly changed under Chapter 13. So you are usually required to pay your full monthly mortgage payment, and to catch up any arrearage, but to accomplish this you are allowed to pay to most of your other debts.

3.  permanently prevent income tax liens, and child and spousal support liens, and such from attaching to your home. The “automatic stay” preventing such liens under Chapter 7 last usually only about 3 months, and there’s no mechanism for dealing with these kinds of debts. Instead under Chapter 13, these liens are prevented throughout the three-to-five-year length of the case.

4.  have the time to pay debts that can’t be discharged (legally written off) in bankruptcy, all the while being protected from those creditors attacking your home. So even if a tax or support lien is already in place before you file, you are given the opportunity to pay the debt while under the protection of the bankruptcy laws. That undercuts the leverage of those liens against your home. Then by the end of your case, the debts are paid and those liens are released.

5.  discharge (write off) debts owed to creditors which could otherwise attack your home. For example, certain (generally older) income taxes can be discharged, leaving you owing nothing. But had you not filed the Chapter 13 case, or delayed doing so, a tax lien could have been recorded, which would have required you to pay some or all of the balance to free your home from that lien. Even most standard debts can turn into judgment liens against your house once you are sued and a judgment is entered. Depending on the facts, a judgment liens may or may not be able to be gotten rid of in bankruptcy.  If instead you file a Chapter 13 case to prevent these liens from happening, at the end of your case the debt is gone, and no such liens attach to your home.

See my next blog post for the other five house-saving tools of Chapter 13.

 

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Saving Your Home Through Chapter 7 and Chapter 13 in Three Scenarios

Here are 3 common scenarios. When is Chapter 7 “straight bankruptcy” enough, and when do you need Chapter 13 “adjustment of debts”? 

 

Assuming that your most important goal is saving your home, here’s how each kind of bankruptcy helps with that goal.

Scenario #1: Current on Your Home Mortgage(s), Behind on Other Debts

Chapter 7:  Would likely discharge (legally write off) most if not all of your other debts, freeing up cash flow so that you can make your house payments. Stops those other debts from turning into judgments and liens against your home. May also allow you not to fall behind on other obligations—income taxes, support payment, utility bills—which could also otherwise turn into liens against your home.

Chapter 13:  Same benefits as Chapter 7, plus often a better way to deal with many other special debts, such as income taxes, back support payments, and vehicle loans. May be able to “strip” (permanently get rid of) a 2nd or 3rd mortgage, so that you would not have to make that monthly payment, and paying little or nothing on the balance during the case and then discharging any remaining balance at the successful completion of your case.  Is better at protecting assets than Chapter 7, if you either have more equity in your home than your homestead exemption allows or have any other asset(s) not protected by other property exemptions.

Scenario #2. Not Current on Home Mortgage(s) But Only a Few Payments Behind & No Pending Foreclosure

Chapter 7:  May buy you enough time to get current on your mortgage, if you’ve slipped only two or three payments behind. Most mortgage companies and their servicers (the people you actually interact with) will agree to give you several months—generally up to a year—to catch up on your mortgage arrearage. Generally called a “forbearance agreement”—lender agrees to “forbear” from foreclosing as long as you make the agreed payments. Works only if you have an unusual source of money (a generous relative or a pending legal settlement that’s exempt from the other creditors), or if filing Chapter 7 will stop enough money going to other creditors so you will have enough monthly cash flow to pay off the mortgage arrearage quickly.

Chapter 13:  Even if only a few thousand dollars behind on your mortgage, you may not have enough extra money each month after filing a Chapter 7 case to catch up quickly on that mortgage arrearage.  Lenders seldom voluntarily give you more than about a year to catch up, but if you file a Chapter 13 case that forces them to accept a much longer period to do so—three to five years. That greatly reduces what you need to pay towards the arrears every month, often making it affordable.  

Scenario #3. Many Payments Behind on Your Mortgage(s):

Chapter 7:  Not helpful here unless you have some extraordinary means for paying off the large mortgage arrears. Buys only a few weeks of time, or at most three months or so (if the mortgage lender chooses to do nothing while your bankruptcy case is pending). Also, no possibility of “stripping”a 2nd or 3rd mortgage.

Chapter 13:  As stated above, gives you up to five years to pay off the mortgage arrearage, all of which time your home is protected from foreclosure as long as you maintain the agreed Chapter 13 Plan payments. Assumes that you can at least make the regular mortgage payment consistently, along with the arrearage catch-up payment. Does not enable you to reduce the first mortgage payment amount, although in some situations you may be able to “strip” your 2nd or 3rd mortgage.

 

CAUTION: these are just the very basic advantages and disadvantages. There are lots of other twists and turns which will likely apply to your unique scenario. Be sure to meet with an attorney for the best game plan for you to meet your goals. 

 

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A Sample Simple Save-Your-Business Chapter 13 Case

A business Chapter 13 case does not have to be complicated. Here’s how it can work.

 

It’s true that if you own a business that usually means you have a more complicated financial picture than someone punching a time clock or getting a regular salary. So usually if does take more time for an attorney to determine whether and how bankruptcy could help you and your business. But saving a business in the right circumstances can be relatively straightforward and extremely effective.

A good way to demonstrate this is by walking through a realistic Chapter 13 “adjustment of debts” case.

Jeremy’s Story

Jeremy, a single 32-year old, started a handyman business when he lost his job a little more than three years ago. He had ten years steady experience before that in construction and maintenance work. A hard worker and self-starter, he’d been itching to run his own business. He’d slowly accumulated the tools and equipment he needed, and had taken some courses at the local community college in small business management. He had decent credit at the time, owing nothing except his modest mortgage that he had never been late on plus about $2,800 spread out on a number of credit cards. Jeremy had always lived in the same area along with most of his extended family, so he had tons of contacts, and had a great reputation as a responsible guy who could fix anything. He had begun to accumulate some money to get him past the start-up of his business, but then his employer ran into financial problems and he was reluctantly laid off. So Jeremy decided to take the risk of starting his business in spite of having very little working capital. He had $8,500 of credit available on his credit cards if he got desperate.

His business started off slowly, partly because he didn’t have the cash to invest in advertising. But he was creative in setting up a website and using social media, and worked very hard building a customer base and a good business reputation. His income crept steadily upwards, but way too slowly. Over the course of the first year Jeremy maxed out his credit cards to keep current on his mortgage, feed himself, and keeps the lights on. But he simply didn’t have enough money to pay any estimated quarterly income taxes to the IRS, falling behind $3,500 to them that year.

Then during the second year of his business, Jeremy managed to keep current on the increased payments on his credit card debts but couldn’t pay them down any. Plus he fell behind another $6,000 in income taxes. Then recently, towards the end of his third year of business, after again failing to pay any estimated quarterly income taxes and falling another $4,500 behind, the IRS required him to start making $400 monthly payments on his $14,000 debt, plus to pay his estimated quarterly payments going forward. As a result he started not being able to keep current on his credit card payments, leading to ratcheted-up interest rates, pushing him over the credit limits and into the vicious cycle of large extra fees piling up. And now he’s missed two payments on his mortgage, putting him $3,000 in arrears.

In spite of all these distractions Jeremy’s business now has reasonably steady income, which continues to increase, slowly but quite consistently. His accumulated debt problems ARE taking a toll on his ability to focus on growing his business. In spite of this he still very much likes his work and being his own boss, and realistically believes he can keep increasing his income, especially as the economy improves. He very much wants to keep his business going.

But his creditors have him in an impossible situation. If he misses a payment, the IRS could levy on his business equipment or even garnish his business customers—requiring them to pay the IRS instead of him and trashing his very hard-won reputation. A couple credit cards creditors are sending their accounts to collection agencies. He not too far behind on his mortgage but still doesn’t see how he could catch up on even just two missed mortgage payments considering his other financial pressures.

The Chapter 13 Solution

If Jeremy met with an experienced business bankruptcy attorney, this is likely what the attorney would tell him that a Chapter 13 case would accomplish:

  • Cancel the $400 monthly payments to the IRS, giving him 5 years to pay that debt, with no additional ongoing interest or penalties during that whole time. This would significantly reduce the amount that he would need to pay each month and overall.
  • Stop all collection efforts by the credit card creditors and any collection agencies. They would only receive any money after Jeremy caught up on the house arrearage and paid off the income taxes, and then only to the extent that Jeremy’s budget would allow.
  • Immediately protect all his business and personal assets—tools and equipment, his business truck and/or personal vehicle, receivables owed by customers for prior work, and his business and personal bank and/or credit union accounts.
  • Enable Jeremy to concentrate on his business by greatly relieving his month-by-month financial burden, as well as save him a lot of money in the long run.
  • At the end of his 3-to-5 year Chapter 13 case, Jeremy will be current on his mortgage, he would owe nothing to the IRS, and he would have paid as much as he could afford on the credit cards, with any remaining amount discharged (legally written off).

 

As a result the business that he loves and in which he has invested so much hope and effort would be thriving and providing him a decent livelihood. 

 

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