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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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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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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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