A Second Mortgage “Strip” through Chapter 13

“Stripping” off a second mortgage has major immediate and long-term benefits.

 

In a blog post last week we listed 10 ways Chapter 13 helps you keep your home. Here’s the second one of those:

2. Stripping Second or Third Mortgage

Under Chapter 7 you simply have to pay any second (and third) mortgages on your home or lose the home. However, Chapter 13 gives you the possibility of “stripping” that junior mortgage lien off your home’s title. This could potentially save you hundreds of dollars monthly. You could also end up paying just a fraction of the entire balance, or sometimes paying none of it all. That could save you many thousands or even tens of thousands of dollars in the long run.

How do you qualify for this junior mortgage lien “stripping”? The key factor is your home’s value. The second mortgage can be “stripped” from the home’s title if the entire value of the home is fully encumbered by liens legally superior to the second mortgage lien. “Legally superior” liens are those liens ahead of the second mortgage lien on the title.  All of the home’s equity is fully absorbed by liens ahead of it on the title. So the second mortgage debt is declared to be an unsecured debt, and is treated accordingly.

To bring this explanation to life let’s show how this incredible tool works by example.

An Example

Assume that your home is worth $200,000. It lost a lot of value during the “Great Recession” of 2008-2010 and hasn’t gained it back yet. You owe a first mortgage of $210,000 and a second mortgage of $18,000. The second mortgage has monthly payments of $250, with a bit more than 8 years to pay on it. It has a high interest rate of 8%—your credit wasn’t the best when you got this second mortgage loan.

Also assume that you were unemployed for a spell and so fell behind on both mortgages, as well as on other debts. You have a new job but it doesn’t pay as well as the earlier one, so you need help.

You very much want to keep your home. You’ve had it forever and it’s close to your new job. Home and apartment rents are rising in your area. You know that mortgage qualifying standards are tighter now than they were before the Great Recession. So for good reason you’re afraid that it would be a long time before you could buy a home again.

So you need a Chapter 13 “adjustment of debts” to catch up on your home obligations and to deal with your other debts.

“Stripping” Your Second Mortgage

In this scenario you’d be able to “strip” your $18,000 second mortgage off your home’s title through Chapter 13. Your bankruptcy lawyer would file special papers in the bankruptcy court to do so. Those papers would show that the home’s value—$200,000—is less than the amount of the first mortgage—$210,000. So all of the home’s equity is fully absorbed by the lien legally ahead of the second mortgage. As long as the bankruptcy judge accepts this to be true, he or she would declare the second mortgage lien to be “stripped” off your home’s title. Then the debt you owe on the second mortgage—the $18,000—would be treated as an unsecured debt.

The Great Benefits

A number of very good consequences would flow from this.

  • You could immediately stop making the $250 monthly payments. This would make it easier for you to pay the first mortgage’s monthly payments.
  • To the extent you were behind on the second mortgage, you would not need to catch up. This means that during your Chapter 13 case you could concentrate on catching up on your first mortgage. If behind on 6 payments of $250 on your second mortgage, that’s $1,500 you would not have to pay.
  • Your now-unsecured $18,000 second mortgage balance is treated in your Chapter 13 payment plan just like any other unsecured debt. That is, you’d pay it only as much as you could afford to during the 3-to-5-year life of the plan. In most plans there is only a certain amount available to pay all unsecured creditors. So adding the second mortgage balance often doesn’t increase what you pay into your payment plan. It’s not unusual for the second mortgage balance to be paid only a few pennies on the dollar. In fact, sometimes you pay NOTHING on that second mortgage balance (and on your other general unsecured debts).
  • At the end of your successful Chapter 13 case the entire unpaid second mortgage balance is “discharged”—legally written off. Assume for a moment that your payment plan allowed you to pay nothing on this second mortgage balance. Realize that the resulting savings would be substantially more than the $18,000 present balance. That’s because of the substantial amount of otherwise accruing interest that you would also avoid paying. The $18,000 balance at 8% with $250 payments would take a little more than 8 years to pay off, thus including about $6,600 in interest you’d also avoid paying.
  • Lastly, “stripping” the second mortgage off your home’s title would greatly improve your potential equity picture. Instead of owing $228,000 ($210,000 first mortgage + $18,000 on the second mortgage), you’d owe only $210,000. You’d be that much closer to building equity in your home as you paid down the first mortgage and as the home increases in value.

 

Keeping Your Home through Chapter 13

Chapter 13 gives you much more time to catch up on your unpaid mortgage payments. That can be reason enough choose this option.

 

Filing either a Chapter 7 “straight bankruptcy” case or a Chapter 13 “adjustment of debts” one stops a pending home foreclosure. And they can both prevent one from begin started. Assuming you’re behind on your mortgage and want to keep your home, whether you should file under Chapter 7 or Chapter 13 depends on how far behind you are and how much help you need in catching up.

Protection through the “Automatic Stay”

Filing either a Chapter 7 or Chapter 13 case immediately imposes the “automatic stay” on your mortgage lender, and on all your other creditors. This is the federal law which stops and prevents (“stays”) virtually all collection actions against you or your property, including a home foreclosure.

Under Chapter 7 this “automatic stay” protection only lasts a short time, usually about three months or so. And the mortgage lender can even ask the bankruptcy court to cut short that protection.

Buying Some Time with Chapter 7

As we said in our last blog post, Chapter 7 usually lets you keep your home if you are current or not too far behind on your mortgage payments.

Most people who file a Chapter 7 case gain some monthly cash flow because they no longer have to pay some of their debts. Consider the Chapter 7 option if you want to keep your home and after filing bankruptcy you would have enough cash flow to make both your regular mortgage payments plus enough extra to be able to catch up on the late payments fast enough to satisfy your particular mortgage lender(s).

How much time you’ll have depends on the particular lender. About a year is a very rough estimate, but this varies widely so discuss this with an experienced bankruptcy lawyer to get a better idea what your lender will allow in your circumstances.

Buying a Lot More Time with Chapter 13

Instead of buying just a matter of a few months, Chapter 13 can usually give you as much as five years to catch up on your back mortgage payments.

If you are in foreclosure or anticipating that you will be soon, you could easily be tens of thousands of dollars behind on your mortgage. You may also be behind on property taxes and/or homeowner association assessments. You likely need as much time as possible to catch up on these. Stretching the repayment period out as long as five years can greatly reduce what you have to pay each month to catch up. This can make keeping your home much more feasible.

Not Need Lender’s Consent

Under Chapter 7 you are largely at the mercy of your lender regarding how much time you’ll have to get current. So you have to pay the necessary amount each month to accomplish that.

Under Chapter 13 you don’t rely on the cooperation of your mortgage lender. As long as you follow the law in how you and your lawyer put together the Chapter 13 payment plan, and then comply with that plan, the lender has little choice.

It can keep your feet to the fire to make sure you comply with the plan you propose and that the court approves. If you don’t pay as the plan says, you can still lose your home. But you’re much more in the driver’s seat, following a financial plan based on what your budget says you can afford to pay.  

Creative Flexibility

Not only do you get much more time to catch up on your mortgage(s), you also often get a fair amount of flexibility in how and when that happens in relation to your other pressing debts.

For example, let’s say you are also behind on your vehicle loan or child support. Depending on the amount of equity in your home and other factors, you may be able to pay such other even more urgent creditors ahead of or at the same time as you’re catching up on the mortgage.

Sometimes you may even be able to catch up on your mortgage in part or in full through a refinancing of your home. That refinancing may even be purposely delayed a couple years to allow for more equity to build up in your home.

Chapter 13 case comes with other kinds of flexibility. Your payment plan can from the outset reflect future anticipated increases in income or available funds, such as after a child starts school and a spouse begins making an income. That can make the payment plan easier in the meantime.

When financial circumstances change midstream, your Chapter 13 plan can usually be adjusted to reflect changes in your income and expenses.

These various kinds of flexibility make more likely that you can keep your home in the long run.

The Flexibility to Safely Change Your Mind

Your financial or life circumstances could change a year or two after filing your Chapter 13 case so much that you end up deciding you don’t want to keep the house after all.

For example you may get a new job out of the area, or a child may graduate from the local high school and leave home, so that keeping the home is no longer appropriate or necessary.

Under Chapter 13 you can change your mind and sell or surrender the home then, in a more financially protected way.  You can do so by amending the terms of your Chapter 13 payment plan, by converting your case into a Chapter 7 one to discharge any remaining debts, or even by simply dismissing (closing) your case if you don’t need its benefits any longer.

 

Keeping Your Home through Chapter 7

Chapter 7 usually lets you retain your home if you are current (or not too far behind) on your mortgage payments (& other home-based debts).

 

Whether you can keep your home when filing a Chapter 7 “straight bankruptcy” mostly depends on two questions: 1) Are you current or close to current on your mortgage and other debts against your home, and 2) Is the equity in your home protected by the applicable homestead exemption?

Today we focus on your mortgage. Upcoming blog posts will hit other possible kinds of liens against your home, and then the homestead exemption.

Chapter 7 in General

When it comes to your home, Chapter 7 is designed for more straightforward situations with your mortgage and other home-related debts.

Under Chapter 7 if you want to you can generally keep possession of the collateral that is securing any of your debts. You just need to be current or at least close to current on that secured debt.

Whether the secured debt is a vehicle loan, furniture purchase contract, or home mortgage, if current or almost current you would usually be able to keep the vehicle, the furniture, or the home.

(Under most Chapter 7 cases you can usually also get out of owing anything on such secured debts by surrendering the collateral to the creditor. But today we’re focusing on keeping collateral, specifically your home.)

If Current on Your Mortgage

Do you want to stay in your home, are current on your mortgage payments, and will be able to keep up those payments after writing off all or most of your other debts? Then your home and your mortgage will very likely proceed through a Chapter 7 case smoothly without any change.

Compliance with Other Mortgage Requirements

You also need to be in compliance with other conditions of your mortgage contract. Two of the most common problematic ones involve keeping current on homeowner’s insurance and property taxes.

In most mortgage contracts, falling behind on either of these is considered a breach of the contract. So not being current on insurance or property tax constitutes separate legal grounds for foreclosure even if you’re current on the mortgage payments themselves.

This makes sense. If there’s no insurance in effect, your home could be destroyed in a fire and your mortgage lender would have virtually no collateral protecting their debt. If the property tax entity forecloses on the home, the mortgage lender would be foreclosed out along with you.

Often your monthly mortgage payment includes an “escrow” amount covering the homeowner’s insurance premium and property taxes. If so, then as long as you’re current on your mortgage you’re also current on these other obligations.  But sometimes the “escrow” payment only covers one of these, requiring you to pay the other on your own.

If Not Current on Your Mortgage But Not Too Far Behind

Even if you ARE a few months behind on your mortgage payments, you may still be able to file a Chapter 7 case. It depends.

A Chapter 13 “adjustment of debts” may be the better option if you are behind on your mortgage payments. It can also be better if you are behind on insurance or property taxes, have a second mortgage, or have other liens on your home, such as from income taxes or child/spousal support.

But a Chapter 13 case takes SO much longer than a Chapter 7 one—usually 3 to 5 years instead of about 4 months. It has other potential disadvantages as well. So you have some incentive to try to file a Chapter 7 case if you can.

In a Chapter 7 case your mortgage lender will almost for sure require you to catch up on any missed payments. Usually you will have to make your regular monthly payments PLUS enough extra each month to pay off the arrearage within a certain length of time. Usually you will be given no more than a year or so to catch up.

So, you and your attorney need to look closely at your after-bankruptcy budget to figure out how much you could afford to pay extra each month towards catching up. Hopefully since you’re no longer paying the debts being writing off in your Chapter 7 case you’ll be able to pay enough.

How Much Time to Catch Up?

How many months you’d have to bring your account current would naturally determine how much you have to pay in catch-up payments each month. And how much time your particular lender will allow depends on its policies and on your particular circumstances.

Your attorney, who deals with mortgage lenders about such matters every day, likely has experience with your lender and will counsel you about this.

Also, you may qualify for a loan modification—a re-writing of the mortgage terms. The balance is never reduced, but the missed payments could perhaps be wrapped into the new modified mortgage. Then you would no longer have to catch up on the missed payments, but just pay the new mortgage payments going forward. Again, ask your lawyer about the modification option.  

If You Can’t Afford to Catch Up Fast Enough

The reason that Chapter 13 can be a better way to save your home is that it gives you much more time to catch up on late mortgage payments. It can usually buy you as much as 5 years.

Plus as mentioned above Chapter 13 can help with other home- related debts, such as second (or third) mortgages, property taxes, and income tax liens.

Our very next blog post will address how Chapter 13 buys you more time if you need it.

 

A Fresh Start on Your Home with Chapter 13

Adjusting your mortgage and other home-related debts under Chapter 13 can often give your home the very best fresh start.

 

Our last two blog posts have been about two options for when you need help making mortgage payments: a mortgage modification and a forbearance agreement.

In a nutshell, a mortgage modification reduces the monthly mortgage payments through a permanent restructuring of one or more of the terms of the mortgage. A reduction in the principal amount of the mortgage debt is seldom included. So while modification can help in the short-term–if you’re fortunate enough to meet the relatively tight qualifying standards—be careful about what it costs you long-term.

With a forbearance agreement the monthly mortgage payments don’t change. The lender simply gives you a certain number of months to catch up on the unpaid mortgage payments, while at the same time you must also make your regular monthly mortgage payment.

So, mortgage modification addresses a permanent cash flow problem while a forbearance agreement addresses a shorter term cash crunch.

A Chapter 13 “adjustment of debts” can deal with either, in the right circumstances.

Chapter 13 vs. Mortgage Modification and Forbearance Agreement

From the start Chapter 13 is different from these other two options in one significant way—it’s not voluntary on the part of the mortgage lender. Instead of you trying to meet the lender’s qualification standards, you and your attorney put together a plan based on what serves your own best interests. Although you certainly have to follow some rules, you are given a lot of latitude as you do so.

For example, you do have to pay all the first mortgage arrearage before the end of the case, but you’re usually given 3 to 5 years to do so. That’s in contrast to a forbearance agreement which usually only gives you a few months, a year at the most.

And the amount you pay each month can vary depending on what other obligations may be more urgent for you. For example, if you have to catch up on a vehicle loan arrearage, or if you are behind on child support, those can usually be paid ahead of the mortgage arrearage. Or the amount paid on the mortgage arrearage can be reduced while you are paying certain other high priority debts or expenses. This kind of consideration for other debts would simply not be permitted in a forbearance agreement.

As for mortgage modification, you’re usually not required to catch up on the arrearage since that’s wrapped into the rewritten loan. With that advantage, and with a reduced monthly payment, modification can be better than Chapter 13.

Chapter 13 with Mortgage Modification

A mortgage modification can be the most effective in combination with Chapter 13, in a two respects.

First, a Chapter 13 case can help you succeed with a mortgage modification. Without collection pressure from your other creditors, you stand a better chance of getting past the modification’s trial period and getting a permanent modification. And by significantly reducing how much you pay your creditors each month, you will more likely be able to stick to the terms of the mortgage modification in the long run.

Second, a mortgage modification can help you succeed with your Chapter 13 case, in a couple ways:

  • A mortgage modification results in you paying less on your first mortgage as a result of lower monthly payments and no arrearage to catch up on.  With less to pay towards the mortgage, that leaves more to pay other high-priority debts—such as recent income taxes and child support arrearage—that must be paid in full in a Chapter 13 plan in a maximum of 5 years. This means that a plan that would have been difficult to pay off in time becomes more feasible.
  • Similarly, with less money going towards the mortgage because of a modification, a plan that would have taken up to 5 years could be shortened to 3 years. Your income during the months before filing determines whether you plan must run a minimum of 3 years or 5 years. But even if you are only required to pay for 3 years, you are allowed to stretch the plan longer to reduce the monthly payment and better fit your budget. You’ll more likely be able to finish in 3 years if your monthly mortgage obligation is less, giving you more money to pay into your Chapter 13 plan. 

 

A Fresh Start with a Forbearance Agreement

Whether you’re about to fall behind on your mortgage or have already done so, a forbearance agreement avoids foreclosure while you catch up.


Quick Definition

A forbearance agreement gives you short-term relief to deal with a temporary period of financial hardship. Your mortgage lender agrees, either in advance or after the fact, to accept a period of reduced or suspended monthly payments in return for your agreement to return to full monthly payments and catch up on the missed payments within a certain length of time. The lender agrees to not foreclose—to “forbear” from foreclosing—as long as you make the agreed regular and catch-up payments. You are given this grace period to bring the mortgage current and then return to making just the regular monthly payments.

Compared to Mortgage Modification

Forbearance agreements are usually much easier to qualify for and quicker to negotiate with the lender. After all you are not changing most of the terms of the mortgage—almost always the regular monthly payment, the interest rate, and the length of the overall mortgage don’t change. You’re just forgiven for a period of time of being in default on the payments, and are then required to catch up relatively quickly. A forbearance agreement does not make your mortgage more affordable long-term, but rather gets you back in good graces with the same mortgage you signed up for originally.

In contrast, a mortgage modification changes the terms of the mortgage to make it more affordable long-term, by reducing the monthly payment. But besides being relatively difficult to qualify for and process, mortgage modifications usually don’t reduce the principal amount you owe but rather make it somewhat easier to pay, with a reduced interest rate or a longer term (for example, 40 years instead of 30). See our last blog post for more about mortgage modifications.

The Relatively Rare Solution

So forbearance agreements are only appropriate for that relatively rare situations  in which you only miss a few months of mortgage payments and then get to a point in which you can not only afford the regular payments again but also pay a significant amount extra each month to catch up on the missed payments within a relatively short period of time.

The amount of time to catch up varies with each mortgage lender and the circumstances of each case. Periods of 6 to 10 months are common, seldom more than a year.

Take the example of a mortgage with a monthly payment of $1,500. If the homeowner missed 5 payments because of a job loss, he or she would be $7,500 behind on the mortgage. After the lender starts a foreclosure, the homeowner finds steady employment and negotiates a forbearance agreement to catch up on that $7,500 over the next 10 months. He or she would have to make the regular $1,500 monthly payment plus $750 extra every month for 10 months. During those 10 months the foreclosure would be put on hold. At the end of that time the homeowner would be current on the mortgage and the foreclosure would be canceled.

Forbearance Agreements and Bankruptcy

For most people, coming up with the extra monthly amount—the $750 in the above example—is impossible because of other debts. So forbearance agreements are often used together with Chapter 7 “straight bankruptcy.” Paying the catch-up payment can be much more feasible if you don’t have to pay most or all of your other debts at the same time.

Forbearance agreements do not usually work with Chapter 13 “adjustment of debts” payment plans. Instead Chapter 13 is often used instead of forbearance agreements if you simply don’t have the cash flow to make the catch-up payments that your lender would require of you. Chapter 13 can usually allow you to catch up over a much longer period of time—3 to 5 years instead of a year or less with a forbearance agreement. Stretching out the catch-up payments under a Chapter 13 plan lowers that monthly amount significantly. Chapter 13 may also allow you to stop payments on a second (or third) mortgage, give you longer to catch up on any back property taxes or homeowner association dues, and deal better with income tax liens or other obligations tied to the home. We’ll address the Chapter 13 option more thoroughly in our next blog post. 

 

Chapter 7 and Chapter 13–Stripping a Second (or Third) Mortgage

Stripping a mortgage from the title to your home could save you a tremendous amount of money.

 

 

Two blog posts ago our topic was getting rid of judgment liens, which can be done under either Chapter 7 “straight bankruptcy” or 13 “adjustment of debts.” So if you have a judgment lien (or two) on your home’s title, that will not push you towards one Chapter or the other.

But stripping a second mortgage can only be done through Chapter 13. Because stripping a mortgage from your home’s title can save you so much money, it is often the major reason to file under Chapter 13 instead of Chapter 7.

The Benefit of Stripping Your Second and/or Third Mortgage

If you qualify to remove, or strip, a mortgage from your home’s title, you would not have to pay that mortgage’s monthly payments, would likely pay only a fraction of that mortgage, and get much closer to building equity in your home. Under the right conditions, you can get rid of the debt you owe on a second or other junior mortgage, and get rid of the lien on your home’s title securing that debt.

You can do this by filing a Chapter 13 case if the value of the home is less than the amount owed on the your first mortgage plus any other liens that are ahead of the mortgage being stripped (such as for property taxes or a homeowners’ association).

Lien Stripping

Usually in bankruptcy a lender’s rights to its collateral are respected and protected. For example, if you want to keep your vehicle you have to pay the lienholder. So it’s both unusual and very beneficial to you to be able to get rid of a junior mortgage debt as well as its mortgage lien on your home.

Stop Monthly Payments

If you file a Chapter 13 to strip your second or third mortgage you immediately no longer have to make the monthly payments on that mortgage. And if you were behind on those mortgage payments, you do not have to catch up on those payments.

Improve Your Equity Position in Your Home

If you can get strip a second or third mortgage doing so can bring you much closer to creating equity in your home.

An example will show you how this works. If you had a home worth $200,000, with a first mortgage of $210,000 and a second mortgage of $30,000, you could likely strip that second mortgage through Chapter 13. Instead of having a negative equity of $40,000 ($10,000 from the first mortgage plus $30,000 from the second), after the lien strip the negative equity would be only $10,000, bringing the home much closer to building equity through future increases in the value of the home.

What Happens to the Debt Owed on the Stripped Mortgage?

Chapter 13 allows you to treat the debt being stripped of its mortgage like a “general unsecured” debt.  Those are debts with no lien on anything you own, which are paid only as much as your budget enables you to pay during the life of your 3-to-5-year Chapter 13 case, which is often not very much.

That’s because you are allowed, indeed required, to pay your secured debts and “priority” debts ahead of the “general unsecured” ones. Secured debts include vehicle loans and first mortgage arrearage. “Priority” debts include, for example, income taxes that are not old enough to be discharged (written off), any child and spousal support that you’re behind on, and other legally important debts.

As a result the debt on your mortgage that’s being stripped is usually paid only a few pennies on the dollar, and sometimes nothing at all.

Furthermore, because in most cases you only have to pay a certain amount to the entire pool of your “general unsecured” debts, adding your mortgage debt to that pool usually doesn’t increase what you have to pay in “general unsecured” debts.

For example, let’s say your budget over the course of your 3-year Chapter 13 payment plan requires you to pay—beyond what you are paying to secured and “priority” debts—$5,000 to the pool of your “general unsecured” debts. Imagine that you owe $20,000 in credit card and medical debts, and $30,000 on a second mortgage being stripped. Without that second mortgage debt, the $20,000 in credit card and medical debts would be paid 25%—$5,000 out of the $20,000 owed. When you add the $30,000 second mortgage debt to this pool of “general unsecured” debts the pool increases to $50,000. Paying the same $5,000 during the 3-year plan towards this $50,000 in debt results in the debts now being paid only 10%—$5,000 of the $50,000 owed. The amount you would pay—$5,000—would not change; it would just be spread out over more debts, without costing you any more.

At the Successful Completion of Your Case

Once you get to the end of your Chapter 13 case by having paid whatever your court-approved payment plan required of you, your second (or third) mortgage lien is stripped off your title. Whatever portion of that mortgage that has not been paid through the Chapter 13 payment plan is then discharged—legally written off. Your home no longer has that mortgage on its title or any of that debt against its equity.

 

Mistakes to Avoid–Selling Your Home without First Stripping the Second Mortgage

Selling Your Home without First Stripping the Second Mortgage

 

One way that bankruptcy—Chapter 13 in particular—could save you a tremendous amount of money is with a second (or third) mortgage strip.

 

If you have serious financial pressures inducing you to sell your home, is it partly because of your second (or third) mortgage? Would you it help if you did not have to make that payment anymore? Would you be able to keep your home, maybe even permanently, if you could stop paying that second or third mortgage (or both) and also get relief on your other debts?

If your home is worth no more than what you owe on your first mortgage, that is what the Chapter 13 “adjustment of debts” version of bankruptcy could accomplish for you. That and get you much closer to building equity in your home again.

Secured vs. Unsecured Debts

Debts are either secured by something you own or they are unsecured. Secured debt includes your vehicle loan, contract purchases of furniture and appliances, sometimes secured credit cards, as well as various kinds of debts secured by your home. Debts secured by your home can include not only first, second and third mortgages, but also any property taxes you owe (almost always the first debt against your home’s title, even ahead of your mortgage), sometimes debts to a homeowner’s association, income tax and child/spousal support liens, sometimes judgment and utility liens, and possibly construction liens for any home renovation or repairs.

With many of the kinds of secured debt owed by consumers, the collateral secures only one debt. You generally owe only one vehicle lender secured by your vehicle, for example. As you can see from the list at the end of the paragraph just above, that’s often not true of your home. You can owe a string of creditors secured by your home.

What if your home is worth less than the various creditors that are secured by your home? Are all of them really secured by your home when the home is not worth enough to cover all that debt?

Turning a Secured Second Mortgage into an Unsecured Debt

Chapter 13 enables you to turn your second mortgage into an unsecured debt if your home is worth less than the debts legally ahead of that second mortgage on your home’s title. The law effectively acknowledges that all of your home’s value is eaten up by liens that are ahead of the second mortgage, leaving no equity at all for that debt, making it an unsecured debt.

For example, if your home is worth $200,000, you are $2,000 behind in property taxes, owe $205,000 on your first mortgage, and owe $50,000 on your second mortgage, because the taxes plus first mortgage is more than the home’s value ($207,000 vs. $200,000), through Chapter 13 you could “strip” the $50,000 second mortgage off your home’s title.

Turning a Secured Third Mortgage into an Unsecured Debt

This works with a third mortgage as well, if you have one. If your home is worth no more than the debts legally ahead of that third mortgage—usually any past-due property taxes, the first mortgage balance plus the second mortgage balance—through Chapter 13 you could “strip” that third mortgage off your home’s title.

For example, if your home is worth $250,000, you are $2,000 behind in property taxes, owe $205,000 on your first mortgage and $50,000 on your second mortgage, and also have a $15,000 third mortgage, because the taxes plus the first and second mortgages are more than the home’s value ($257,000 vs. $250,000), the $15,000 third mortgage can be turned into an unsecured debt.

What Happens to the Stripped Second or Third Mortgage Debt?

As long as the court determines that indeed the home is not worth enough to secure ANY PORTION of the second or third mortgage being stripped, you do not have to pay that monthly mortgage any longer. You don’t have to catch up if you’re behind. The debt that had been secured by that mortgage is treated like any other unsecured debt under Chapter 13. It is lumped in together with your other unsecured debts—medical bills, credit cards, unsecured personal loans, and such—and these are all only paid as much as you can afford to pay on this lowest priority category of debts during the three to five years that your case lasts. Since often much of your available income is needed to catch up on your first mortgage, pay income taxes, and maintain your vehicle payments, often the unsecured creditors—including what you owe on the stripped mortgage—are paid only pennies on the dollars.

Then at the end of your successful Chapter 13 case, the second or third mortgage (and sometimes both) lien is permanently taken off your title, and whatever you owed and didn’t pay through the case is permanently written off. You’ve not needed to sell your home out of desperation, and you’re a lot closer to building equity in it again.

 

Catching Up on Your Mortgage through Chapter 13–Part 2

More answers about how you can have up to 5 years to catch up on your past-due mortgage payments.

 

Today’s blog post, and the last one, answer questions about how Chapter 13 protects your home, your other assets, and your paycheck while you take care of your obligations within a reasonable budget. See my last blog post about:

  • an example how this catching up with a mortgage actually works
  • whether the mortgage lender’s cooperation is needed
  • finishing your payment plan in 3 years instead of 5

Now on to today’s questions.

How Are Overdue Property Taxes Handled?

If you are paying your home’s property taxes as part of your mortgage payment, and you’ve fallen significantly behind on those mortgage payments, the lender may have paid some past due property taxes with its own money. If so, the lender would have added the amount it advanced for your taxes into the total amount that you are behind. Then you would have the length of your Chapter 13 plan to pay your lender that tax amount, in the same way that you would catch up on the back mortgage payments.

If your mortgage lender hasn’t yet paid an overdue property tax, you would pay that tax directly to the county or other tax authority over time in your payment plan. Your home would be protected from tax foreclosure in the meantime. Your lender would also not be able to use the overdue property tax as justification for its own foreclosure, as long as you are making progress on catching up, as well as keep current on new property taxes as they come due during your case (as well as kept up on the mortgage itself).

In the same way, if you have fallen behind on property taxes paid directly to the county or other tax authority (not through your mortgage lender), your Chapter 13 plan would include payments to that tax authority until you were caught up.

What If the Mortgage Lender and Homeowner Disagree about the Amount Past Due?

Chapter 13 has a good mechanism for determining the accurate amount of the arrearage (including any late charges, attorney fees and other costs), which is often a matter of dispute. All creditors, including your mortgage lender, who want to be paid through your Chapter 13 plan are required to file a document in  bankruptcy court—a “proof of claim.” This documents state the total amount owned, the amount of arrearage and how it is calculated, as well as an itemization of any additional fees. You as the debtor then have the opportunity to object to any errors in that proof of claim. The bankruptcy judge is a convenient and experienced adjudicator if there is a dispute.

This issue has been a controversial one during the past 5-10 years because lenders have often been inaccurate and unclear about the amounts on their proofs of claim. This particularly became a problem when lenders added fees to the balance without telling the homeowners. As a result the homeowners would think that they were current only to learn, often after the completion of their Chapter 13 case, that apparently they were still behind. Bankruptcy Rule 3002.1 was put into place to solve this problem. This rule requires lenders to give timely notice of the amount owed and any changes to the amount, and provides for serious consequences if lenders fail to follow these rules.

What If Circumstances Change and the Homeowner No Longer Wants the House?

One of the great features of Chapter 13 is its flexibility. So you CAN change your mind and surrender your house part way through your case. Or in the right circumstances you could even sell the house.  Either way at that point you can either stay in the Chapter 13 case or get out of it.

If you decided to give up your house midstream you could stay in the Chapter 13 case if there were still worthwhile reasons to do so unrelated to your house. For example, you could continue the case if you had other debts best handled in a Chapter 13 case—such as income taxes, support obligations, or possibly student loans. Your attorney would work with you to amend your plan to stop payments going to the house and redirect them elsewhere.

But if you filed a Chapter 13 case solely because of your house and now no longer needed or wanted to catch up on the arrearage, your attorney could either “convert” your case into a Chapter 7 one or simply end the Chapter 13 case by “dismissing” it. More likely your case would be converted into a Chapter 7 one to finish taking care of your debts, including possibly debts related to your now-being-surrendered house.

 

Catching Up on Your Mortgage through Chapter 13–Part 1

If you’re behind on your mortgage, Chapter 13 gives you up to 5 years to catch up. How does this actually work?

 

Various tools can help you keep your home when you file a Chapter 13 “adjustment of debts” case. The most basic of those tools is protection from foreclosure and other collection efforts by your mortgage holder for up to 5 year while you catch up on any back payments.

If you are many thousands of dollars behind on your home mortgage, you need to fully understand how this catch-up tool works before you can decide whether Chapter 13 is the help you need. This blog post, and the next one, should answer your biggest questions about this.

A Simple Example

Let’s say your monthly mortgage payment is $1,500 and you’ve missed 10 payments, so you are $15,000 behind. If this $15,000 were paid over the full 60 months of a 5-year Chapter 13 plan, that would be $250 each month. ($15,000 divided by 60 = $250.)

If you filed a Chapter 7 case instead, you’d likely be given about a year or so to pay that arrearage—amounting to about an extra $1,250 per month. So you’d likely have to pay close to that amount IN ADDITION to the $1,500 regular payment over the course of a year, which would be impossible for most people.

Contrast this to paying $250 per month through Chapter 13. If even this much lower amount seems hard to you, be aware that this would almost always come with the elimination or significant reduction in what you would be paying to your other creditors.

(To keep the above calculation simple here, we’ve not included some other details, such as mortgage lender late fees, maybe some attorney fees, and probably some other costs, as well as Chapter 13 trustee fees, which would all skew the numbers.)

Does My Mortgage Lender Have to Give Me That Much Time under Chapter 13?

Most of the time, yes, your mortgage lender must give you time, although it may be able to attach conditions in its favor.

Using the above example, the lender would almost always have to accept the $250 per month arrangement, and give you an opportunity to make those payments under your Chapter 13 plan. But if the mortgage lender is aggressive, it may be able to impose some conditions on this, especially if you have little or no equity in the home or if you have been especially erratic on the mortgage payments.

These conditions could be potentially dangerous to you. For example, the lender could require conditions stating what would happen if in the future you failed to pay either the arrearage payment or the regular monthly mortgage payment on time. If so, that could automatically trigger the bankruptcy court’s permission for the lender to start (or re-start) foreclosure proceedings.

So, Chapter 13 gives you a relatively long time to catch up on your missed mortgage payments, but the system is not very patient with you if you are then not able to keep to that payment schedule.

What If I Don’t Need 5 Years to Catch Up?

You’re certainly not required to use the full 5 years, if you can pay off the arrearage and the rest of your Chapter 13 obligations (such as any property and recent income taxes or child/spousal support arrearage) faster. Using the above example, $15,000 in missed mortgage payments spread over 36 months would require about $417 per month (again, excluding some likely extra fees), instead of $250.

Generally you want to finish your Chapter 13 case as soon as you can, but should keep your monthly payment low enough to make more likely that you will be able to complete it successfully. Most cases must run at least 3 years. If your pre-bankruptcy income qualifies you for a 3-year plan (instead of requiring a 5-year one), you are usually allowed to have a plan that lasts anywhere between 36 and 60 months, depending on how much “disposable income” you have and how much in mortgage arrearage and other debt you have that must be paid within the length of your Chapter 13 plan.

 

Making Sense of Bankruptcy: Choosing between Chapter 7 and Chapter 13 to Save Your Home

If you’re behind on your home mortgage, when would a Chapter 7 regular bankruptcy be enough vs. needing the benefits of a Chapter 13 plan?

 

Here’s the sentence that we’re explaining in today’s blog post:

If your home is threatened by foreclosure, Chapter 7 usually buys you relatively little time but maybe enough if you 1) can catch up on the mortgage arrearage after writing off your other debts, 2) can qualify for a mortgage modification, or 3) have decided to leave; otherwise Chapter 13 can usually buy you much more time and give other big advantages.

The filing of either kind of consumer bankruptcy stops a pending home foreclosure, or can prevent one from begin started. But whether you should file a Chapter 7 or Chapter 13 case depends on your goals with the home and your broader goals, and on how much help you need in reaching them.

Buying Some Time with Chapter 7

Filing a Chapter 7 case immediately imposes the “automatic stay” on your mortgage lender, and on all your other creditors. This is the federal law which freezes (“stays”) virtually all collection actions against you or your property, including a home foreclosure. And it prevents new collection actions as long as the “automatic stay is in effect. This stopping and preventing of foreclosures includes both non-judicial ones and those involving a lawsuit. What’s crucial is to file on time, because once the foreclosure has progressed beyond a certain point the “automatic stay” can no longer help, even if you are still occupying the home.

The other crucial timing aspect under Chapter 7 is that the “automatic stay” protection only lasts a short time, usually about three months or so. And the mortgage lender can even ask the bankruptcy court to cut short that protection. As a result filing a Chapter 7 case is primarily worth considering in the following three situations.

First, Catch up on the Mortgage Arrearage

Most people who file a Chapter 7 case gain some monthly cash flow because they no longer have to pay some of their debts. Consider the Chapter 7 option if you want to keep your home and after filing bankruptcy you will have enough cash flow to make both your regular mortgage payments plus enough extra to be able to catch up on the late payments within about a year.

Most mortgage lenders will consider having you to enter into what is often called a forbearance agreement, in which they agree to “forbear” from foreclosing as long as you resume and then consistently make the regular mortgage payment plus an agreed monthly amount to catch up. How long you have to catch up depends on each lender and your individual circumstances. Ask your attorney, who may have some experience with your lender.

Second, Qualify for a Mortgage Modification

You may have started a mortgage modification with your lender but time is running out before a pending foreclosure. Or you may not have been aware that you could qualify for a modification that would reduce your mortgage payment(s) and/or not require you to catch up on all or part of your missed payments, and want to apply. Filing a Chapter 7 case may give you enough time to finish or go through a mortgage modification process.

Third, You’ve Decided to Leave

If you’ve fully investigated your options and have decided that it’s best to surrender the house back to your lender, you may want to make the move in a less rushed, calmer way. If you only need another few weeks or months before you can move, a Chapter 7 bankruptcy filing would stop any immediate foreclosure and/or prevent one from being started for a while. The lender may even back off altogether during the three months or so while the bankruptcy case is active, or may be willing to agree upon a date for you to leave that will work with your schedule. The lender might even be willing to pay you to move by a date certain, in return for the lender saving time and money in not having to foreclose and/or evict you.  And at worst, even if your lender is not so amenable you will likely have at least an extra few weeks—and more likely an extra few months—of rent-free housing.

Buying a Lot More Time with Chapter 13

Instead of buying a relatively short time, Chapter 13 can usually give you as much as five years to catch up on your back mortgage payments. If you are in foreclosure or anticipating that you will be soon, you could easily be tens of thousands of dollars behind on your mortgage. You may also be behind on property taxes and/or homeowner association assessments. You likely need as much time as possible to catch up on these. By stretching the repayment period as long as five years, this lets the monthly catch-up payment be that much lower, making keeping your home more feasible.

Other Big Chapter 13 Advantages

Beyond giving you more time to catch up, Chapter 13 gives you a flexible and powerful package of other benefits. Instead of being at the mercy of your mortgage lender about how the amount of time you will have to catch up, you are much more in control of that process. Very importantly, you are usually allowed to fit your mortgage obligations in with your other important creditors. This includes other creditors related to your home, such as property taxes, any homeowner association dues, and income tax liens on your home. And such home-related obligations can be taken care of while simultaneously satisfying other crucial creditors, such as a vehicle loan (including possibly reducing its payments through “cramdown”), and/or any child or spousal support arrearage.

Chapter 13 also may allow you to “strip” a second or third mortgage off your home’s title, so that you would no longer need to make that monthly payment. This could make the difference in your home being affordable. And this mortgage “strip” could reduce the debt on your home by tens of thousands of dollars and make you much closer to building equity in it.

Finally, a Chapter 13 case comes with a fair amount of flexibility during the period you’re in it. Your payment plan can usually be adjusted to reflect changes in your income and expenses, making more likely that you could keep your home in the long run. Because of this flexibility even if your motivation for keeping the home changes while you’re in the case—such as if you get a new job out of the area—you can change your mind and sell or surrender the home then, in a more financially protected way.