When it’s smart to file a 3-to-5-year Chapter 13 case to prevent a home foreclosure and be able to keep it permanently, or to sell it later.
What Chapter 13 Can Do?
For good reason Chapter 13 “adjustment of debts” is called the “save your home” bankruptcy option. It gives you so many advantages towards that goal. A Chapter 13 case can:
- give you three to five years to catch up on your arrearage, greatly reducing the monthly cost of catching up, making it much more feasible to hang onto your home
- allow you to “strip” your second (or third) mortgage off your home, saving hundreds of dollars per month and usually tens of thousands (or sometimes even hundreds of thousands) of dollars over the time you keep the home
- enable you to take care of other liens on your home—such as back property taxes, income tax and child support liens—usually in a very favorable way
- protect any equity in your home beyond the applicable homestead exemption
- reduce or even eliminate what you pay to many of your other creditors so that you can focus on preserving your home
- allow you to pay other very important debts—such as your vehicle loans, income taxes, child and spousal support and arrearage—in tandem with or sometimes even ahead of your home arrearage payment
- “avoid” judgment liens, taking them off your title and then discharging the debts that caused those liens (also available under Chapter 7)
- allow you in many circumstances to sell or surrender your home whenever you choose to do so, whether you planned to do so at the beginning of the case or because your circumstances change
- throughout the process not only protect your home from foreclosure by your mortgage lenders, but also prevent new liens attaching to your home, such as for previously unpaid income tax or child support
Let’s illustrate how to save a home under Chapter 13 with an example. To keep the story manageable, it will only include the first three in the list above.
Jerry owns a home that was worth $310,000 in 2006, but is now worth $250,000. He owes $255,000 on his first mortgage, and $35,000 on his second mortgage, is significantly behind on both, and just missed paying his annual property tax of $2,000.
Long-divorced, he shares custody with his 16 year old son, who thinks he wants to enlist in the Navy as soon as he turns 18. At that point Jerry would like to move to another part of the country where job opportunities are better for his line of work. He currently has steady work, but the last three-four years has been really rough financially. He owes:
- $28,000 in credit cards
- $12,000 for medical bills incurred while he was unemployed and uninsured
- $3,000 in federal income taxes from 2009 when he did not have enough withheld from his wages; he knew he owed so he didn’t file this tax return until last year, and the IRS just recorded a tax lien on it
- $2,000 in back property taxes on his home
- $8,000 in arrearage on his 1st mortgage
- $3,000 in arrearage on his 2nd mortgage
The Chapter 13 Solution
Jerry tells his bankruptcy attorney about his hope to move in two years, but he’s not sure if his son might not change his mind about joining the military. If not, he might still want to keep his home in case his son needs to stay there. So he’d like to keep his options open, in part also to see whether his home’s value will keep on edging up as it finally seems to be doing. His attorney advises him to file a Chapter 13 case. He agrees, and it accomplishes the following:
- Jerry has five years to catch up on the $8,000 in first mortgage arrearage, so though his Chapter 13 plan he pays about $150 per month towards that. If instead he’d filed a “straight bankruptcy” Chapter 7 case, most likely his lender would have required him to catch up within a year, amounting to payments approaching $700 a month, which Jerry simply could not have paid.
- His attorney successfully files a motion to “strip” the second mortgage off his home, which can be done because the home is worth less than his first mortgage. In addition to saving Jerry the monthly payment of $310 dollars per month, he avoids paying the $3,000 in arrearage. And maybe most importantly, this brings his debt on the home much closer to its value.
- He has to pay both the $2,000 back property taxes and the $3,000 in income taxes, but he would have had to no matter what, including if he had filed a Chapter 7 case. The property tax is a lien on his home that comes even ahead of his first mortgage. Being behind on that also gives his mortgage lender another reason to foreclosure if he doesn’t take care of it. The income taxes have to be paid in full because he filed the returns less than two years ago. But he doesn’t have to pay any additional interest or penalties because the income tax lien was unsecured, since there was no equity in the home beyond the first mortgage. Both the property and income taxes are put into Jerry’s Chapter 13 plan, the total payment amount for which is based on his income and expenses.
- The $40,000 of his other debts—$28,000 in credit cards and $12,000 in medical bills—as well as his second mortgage balance of $35,000, do not have to be paid anything as long as Jerry can only afford to pay the obligations stated above within the plan’s five years (and sometimes it’s as short as three years).
- In two years when his son turns 18, Jerry can keep the Chapter 13 plan going as originally proposed and approved, and continue living in the home. If so, when he finishes his case, he will have caught up on his first mortgage, paid off his back property and income taxes, and owe no other debts. Or at the two year mark, he would likely be able to sell the home and move, at which point his plan could be amended to account for his changed circumstances. Or instead, depending on his circumstances at that point, he could convert his case into a Chapter 7 one, discharge his debts and be debt-free that much faster.