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Bankruptcy Helps You Afford Your Mortgage

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Bankruptcy frees up cash flow for your mortgage payments. Chapter 7 does so by writing off other debts. Chapter 13 does so more creatively. 


 

Both Chapter 7 and Chapter 13 Improve Your Cash Flow

A Chapter 7 “straight bankruptcy” case would very likely quickly write off (“discharge”) many of your debts. For many people it discharges most of their debts, maybe even all of them except their home mortgage. That frees up cash flow so that you can better afford to pay your mortgage.

A Chapter 13 “adjustment of debts” case is different but has a similar result. It would very likely reduce payments on most or all of your non-mortgage debts. The amount you pay monthly on your debts is often radically reduced. Plus Chapter 13 deals much better with a variety of dangerous debts. The end result is also to free up cash flow so that you can better afford to pay your mortgage.

Let’s take a closer look at these two options.

Chapter 7 Helps You Pay Your Mortgage

Are you current or almost current on your home mortgage, but only because you are not making required payments on some of your other debts? And/or are you not spending what you reasonably should be on expenses such as food, clothing, or doctor/dental visits?

Chapter 7 legally allows you to immediately stop paying most of your debts. This is accomplished through the “automatic stay,” which stops virtually all collection activity against you. (Section 362 of the U.S. Bankruptcy Code.)

Then, under Chapter 7 the bankruptcy court discharges these debts 3 to 4 months after you file your case. (Section 727 of the Bankruptcy Code.)

So if you’ve been struggling to pay your mortgage, Chapter 7 gives you huge relief. You immediately don’t have to pay some or all of other debts that you’ve been paying. So you can better afford to pay your home mortgage.

If you’ve not been paying creditors you should have been, Chapter 7 stops them from coming after you later.  This prevents them from suing you and garnishing your wages, taking away your ability to pay your mortgage later. So you get long-term relief.

Also, you can better afford to pay essential home obligations, like your property taxes and homeowner’s insurance. If you are behind on either of these, Chapter 7 helps with this immediately and long-term.

Chapter 13 Helps You Pay Your Mortgage, Helping Both Less and More

A Chapter 13 case may help your cash flow differently than Chapter 7. Usually you do continue paying something to all your creditors (although not always). However, if you have certain special debts, Chapter 13 helps your cash flow much more than Chapter 7.

Chapter 13 also helps more than Chapter 7 if you are behind on or struggling to pay your mortgage, your homeowner’s insurance, or the property taxes.

Let’s look separately at these two ways Chapter 13 help more than Chapter 7.

Chapter 13 Helps Your Cash Flow More if You Have Certain Kinds of Debts

Chapter 7 does not discharge all debts. Back child and spousal support, other divorce-related debts, recent income taxes, and student loans usually are not discharged. If you owe any of those, you will have to continue paying them. In the case of child/spousal support, the filing a Chapter 7 case does not stop its collection at all. (Section 362(b)(2) of the Bankruptcy Code.) With the other debts, collection against you can resume 3-4  months later when the case is completed. (Section 362(c)(2).)

In contrast, filing a Chapter 13 case does stop the collection of these “nondischargeable” debts. As with Chapter 7, the “automatic stay” protection against collection ends when the Chapter 13 case is finished. But with a successful Chapter 13 case that usually doesn’t happen for 3 to 5 years.

More importantly, Chapter 13 provides a great way for you to pay these special kinds of debts in the meantime. You do so based on a reasonable budget, while being protected from all of your creditors. So when your Chapter 13 payment plan is finished, you have paid off or brought current your nondischargeable debts. You no longer need the “automatic stay” protection.

By forcing these special creditors to accept payments based on your budget, you protect your ability to pay your mortgage. 

Chapter 13 Helps You Catch up on Your Home Mortgage, Insurance, and Taxes

If you are behind on your mortgage payments, Chapter 13 provides one of the best ways possible to catch up. You have 3 to 5 years to catch up. You do have to continue/resume making your ongoing monthly mortgage payments. The arrearage catch-up payments are incorporated into your single monthly Chapter 13 plan payment. As mentioned above, that plan payment amount is based on your reasonable budget. Other more urgent obligations (such as catching up on child support or maybe a vehicle payment) can sometimes go ahead of catching up on your mortgage for a while. So Chapter 13 can be quite flexible.

If you are behind on homeowner’s insurance, that’s a serious problem. That alone is grounds for foreclosure of your mortgage. The lender will very likely impose its own very expensive “force-placed” insurance, wasting a lot of your money. This often aggravates your already difficult situation. Chapter 13 eases your cash flow so that you can afford to pay your insurance. To the extent force-placed insurance is already in the arrearage amount you owe, Chapter 13 provides a reasonable way to pay it.

If you’re behind on your home’s property taxes, that also is a separate ground for foreclosure. Whether the taxes are part of your mortgage payment or you pay it separately, Chapter 13 can solve this problem. As with homeowner’s insurance, if your lender already paid the taxes, you catch up on that along with the mortgage arrearage. If you pay taxes separately, you catch up with the taxing authority directly, as part of your 3-to-5 year payment plan. Both your mortgage lender and the taxing authority have to cooperate, as long as you fulfill your Chapter 13 obligations. 

Conclusion

Chapter 7 helps very directly, by discharging other debt so that you can better afford to pay your mortgage. Chapter 13 helps by providing a better way to deal with especially dangerous debts that Chapter 7 doesn’t handle well.

 

Protecting Excess Home Equity through Chapter 13

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Chapter 13 can be a highly advantageous way to protect your home equity if that equity is larger than your homestead exemption amount.  

 

The Problem of Too Much Home Equity

Our last two blog posts were about protecting the equity in your home through the homestead exemption. Two weeks ago was about protecting the current equity; last week about protecting future equity. The blog post about protecting current equity assumed that the amount of equity in your home is no more than the amount of your applicable homestead exemption. For example, if your home is worth $300,000, your mortgage is $270,000, that gives you $30,000 of equity. If your homestead exemption is $30,000 or more that equity would be protected in a Chapter 7 bankruptcy case.

But what if you have more equity in your home than the applicable homestead exemption amount? In the above example, what if you had $30,000 in equity but your homestead exemption was only $25,000? Your home could conceivably be sold by the bankruptcy trustee if you filed a Chapter 7 case. Your creditors would receive the proceeds of the sale beyond the homestead exemption amount. Presumably you need relief from your creditors. But clearly don’t want to give up your home and its equity in return for being free of your debts.

What about getting that equity out of the home through refinancing the mortgage? Well, what if you don’t qualify to refinance your home? You may not have enough of an equity cushion. Or your credit may be too damaged. Or maybe you’d qualify for a refinance but it still wouldn’t get you out of debt. That would not be a good option. So what do you do instead to protect your home and that equity?

The Chapter 13 Way to Protect Extra Equity

If your home equity is larger your applicable homestead exemption, then filing a Chapter 13 case can usually protect it.  Chapter 13 “adjustment of debts” protects excessive equity better than Chapter 7. Essentially Chapter 13 gives you time to comfortably pay your general creditors for being able to keep your home.

Why do you have to pay your creditors to be able to keep your home? Remember, if your home equity is larger than your homestead exemption, the alternative is having a Chapter 7 trustee sell the house to get the equity out of it to pay to your creditors. Chapter 13 is often a tremendously better alternative, as we’ll explain here. Also, see Section 1325(a)(4) of the Bankruptcy Code.

Gives You Time to Comfortably Pay

Consider the example above about having $5,000 of equity more that the amount protected by the homestead exemption. Chapter 13 essentially would give you 3 to 5 years to pay that $5,000. This would be done as part of a monthly payment in your Chapter 13 payment plan. $5,000 spread out over 3 years is about $139 per month. Spread out over 5 years is only about $83 per month. Assuming this was part of a monthly payment that reasonably fit into your budget, wouldn’t it be worth paying that to your general creditors if it meant keeping your home and all of its equity?

It’s likely more complicated than this in your personal situation. You may be behind on your mortgage payments or owe income taxes, or countless other normal complications. But at the heart of it Chapter 13 can protect your equity in a flexible way. It’s often the most practical, financially most feasible way.

Chapter 13 is Flexible

To demonstrate Chapter 13’s flexibility, let’s add one of the complications we just mentioned: being behind on your mortgage. Chapter 13 usually allows you to catch up on your mortgage first. So, for example, most of your monthly plan payment could go to there during the first part of your case. Then after that’s caught up, most of the payment could go to cover the excess home equity. The creditors would just have to wait.

Protecting Your Excess Equity “For Free”

Sometimes you don’t have to pay your general creditors anything at all to protect the equity beyond your homestead exemption.  Consider the example we’ve been using with $5,000 of excess equity. Now, using another complication mentioned above, assume you owe $5,000 in recent income taxes. That tax is a nondischargeable” debt, one that is not written off in any kind of bankruptcy case. It’s a “priority” debt, one that you’d have to pay in full during the course of a Chapter 13 case. If you pay all you can afford to pay into your Chapter 13 plan, and it’s just enough to pay your $5,000 priority tax debt, nothing gets paid to your general creditors. You pay the priority tax debt in full before you have to pay a dime to your general creditors. If there is nothing left for the general creditors after paying all that you can afford to pay during your required length of your payment plan, you likely won’t need to pay those debts at all. 

This means that you saved the equity in your home by paying the $5,000 into your plan to pay off the tax debt. That’s a debt you’d have to pay anyway. You’d have to pay it if you didn’t file any kind of bankruptcy case. You’d have to pay it after completing a Chapter 7 case because it does not get discharged. And it also has to be paid in a Chapter 13 case. But in a Chapter 13 case you fulfill your obligation to pay the $5,000 (in our example) to protect your home equity (the amount in excess of the homestead exemption), whether it goes to the pay the tax or goes to pay the general creditors. Under the right facts you save your home and pay nothing to your general creditors.

Conclusion

Chapter 13 can be an extremely favorable way to keep a home with more equity than the homestead exemption amount. At worst, you’d pay the amount of equity in excess of the exemption. But you would do so based on a reasonable budget, with significant flexibility about the timing of payment. At best, you wouldn’t pay anything to your general creditors, when the money instead goes to a debt you must pay anyway, like the recent income tax debt in the example.

These situations depend on the unique circumstances of your finances.  See a highly competent bankruptcy lawyer to get thorough advice about how your circumstances would apply under Chapter 13.

 

Protecting Future Home Equity through Chapter 7

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Protecting present home equity is a sensible focus when considering bankruptcy. Protecting future potential equity can be even more important. 

 

Our last blog posts discussed how to protect the equity currently in your home through the homestead exemption. We discussed property exemptions in bankruptcy in general, and federal and state homestead exemptions in particular. Overall we showed how your homestead exemption can preserve the equity you presently have through a Chapter 7 case.

We mentioned that you can also protect your future home equity through these same tools, but we didn’t describe how. This is worth more attention.

Future Home Equity

Chapter 7 bankruptcy fixates on the present. It deals with debts you have at the moment your lawyer files the Chapter 7 case at the bankruptcy court. In particular, Chapter 7 usually is not interested in new assets you acquire after the date of filing, For example, the money you earn when you go to work the day after filing is outside bankruptcy jurisdiction. Again, for most purposes bankruptcy looks only at what you own on the date of filing.

This is also true as far as your home is concerned. Chapter 7 fixates on how much equity you have in the home at the moment of filing. That is, we look at what the home is worth then, and how much debt there is against it. (The debt includes all valid security interests against the home: mortgages, property taxes, income tax liens, etc.)

But those factors that determine your home equity—the home’s value, and the amount(s) you owe against it—change. They change all the time. The home’s value goes up and down (but mostly up) with the market. The debt on the security interests change every day with interest and every time you make a payment. Generally after filing bankruptcy and getting your financial house in order, you’d make progress paying down home debts. With the home value usually going up and debt against it going down in the years after filing bankruptcy, most people build equity in their home.  

Future Home Equity Greater than Present Homestead Exemption Amount

There’s a good chance that at some point—if you keep your home long enough—the amount of your home’s equity will exceed the applicable homestead exemption.

Take this example. A home is worth $300,000, the mortgage is $260,000, with a remaining equity being the difference, $40,000. Assume the applicable homestead exemption is $50,000. That covers the $40,000 in equity.

Now let’s say that in 3 years the home value increases to $335,000, and the mortgage is paid down to $250,000. The amount of equity at that point is the difference: $85,000. That’s $35,000 more than the applicable $50,000 homestead exemption (assuming that hasn’t been increased in the meantime).

If this homeowner filed a Chapter 7 bankruptcy now, the $40,000 in present equity is protected by the homestead exemption. But what if the homeowner doesn’t file bankruptcy now but waits 3 years to do so? The home equity will at that point have increased well beyond the amount the homestead exemption would protect.

Future Equity is Even More Important than Protecting Your Home Now

Sure, when you’re considering bankruptcy, your focus is on the present. As far as protecting your home equity, mostly all you want to hear from your bankruptcy lawyer is that the equity is covered now. Is the home equity going to be protected?

But as you think about whether you should file bankruptcy, Chapter 7 or Chapter 13, and when to do so, potential future equity is arguably an even more important consideration.

Most directly, there are simply likely more dollars at stake in future equity vs. present equity. In the above example, the person was protecting $35,000 in home equity when filing bankruptcy now. But by the same bankruptcy filing he or she was protecting $85,000 in future equity. Isn’t protecting that future $85,000 at least as important in protecting the present $35,000 in value?  

Conclusion

When you consider whether to file bankruptcy, you’re thinking about both the present and the future. You want relief and a fresh start now so that you can have a more financially peaceful and prosperous future. When thinking about your home, Chapter 7 allows you to preserve your present modest equity now so that it’ll have the opportunity to build it into much larger future equity.

Protecting Your Home Equity through Chapter 7

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You can protect the equity in your home if the amount of equity is no more than the homestead exemption applicable to residents of your state. 


 

Our last two blog posts outlined 15 separate ways that bankruptcy can protect your home now and/or in the future. We’ll be explaining each one of these ways in 15 separate blog posts. Here is the first one—protecting present and future equity in your home through Chapter 7 “straight bankruptcy.”

Property Exemptions in General in Bankruptcy

When you file a bankruptcy case, your assets are protected through a set of “exemptions.” “Exemptions” are categories of your assets that are protected for you from your creditors. Each category usually has maximum dollar limits. (See Section 522 on “Exemptions” in the U.S. Bankruptcy Code.)

Exemptions work somewhat differently in Chapter 7 and Chapter 13. Focusing today on Chapter 7, this is a “liquidation” form of bankruptcy. This means in theory that the Chapter 7 trustee takes—liquidates—anything you own not fitting within an exemption. 

However, the practical effect of exemptions is that most people filing under Chapter 7 get to keep everything they own.

The Homestead Exemption

The homestead exemption determines how much equity in your home you can protect from your creditors. As long as the amount of equity is no more than the homestead exemption amount, your home is safe in a Chapter 7 case.

As a quick example, assume your home is worth $300,000, you owe $265,000, so you have equity of $35,000. If the homestead exemption applicable to your state is $35,000 or more, your home is protected.

This means that your Chapter 7 trustee can’t take the home and sell it to pay the equity over to your creditors.

If you have too much equity, you wouldn’t be filing under Chapter 7. Not if you want to keep your home. See next week’s blog post about preserving home equity that’s more than your homestead exemption through Chapter 13.   

Federal vs. State Exemptions

Bankruptcy law provides a set of federal exemptions, while each state has its own set of exemptions as well. All have a homestead exemption. Can you use either the state or federal homestead exemption? If so, which should you use?

At the outset, since bankruptcy is a federal procedure why is state exemption law applicable at all?                                                    

The U.S. Constitution made bankruptcy a federal procedure to make it uniform throughout the country.  See Article I, Section 8, Clause 3 of the Constitution. But there are many areas in bankruptcy where state laws apply. One such broad area is property law. In an interesting compromise, Congress gave each state the power to require its residents to use that state’s set of exemptions instead of the federal ones. Section 522(b)(2) of the Bankruptcy Code.

So 31 states have decided you must use the state law exemptions. In the remaining 19 states you can use either the state or federal bankruptcy exemptions. Since the list is shorter these 19 states that give you a choice are:

Alaska, Arkansas, Connecticut, Hawaii, Kentucky, Massachusetts, Michigan, Minnesota, New Hampshire, New Jersey, New Mexico, New York, Oregon, Pennsylvania, Rhode Island, Texas, Vermont, Washington, and Wisconsin.

The Amount of Your Homestead Exemption

The homestead exemption amounts vary greatly state to state. For example, Kentucky’s homestead exemption protects only $5,000 in value or equity for an individual homeowner. On the opposite extreme, Nevada’s homestead exemption is $550,000. Plus a number of states—including Texas and Florida– have no dollar limit at all (although do have acreage limitations).

This can get quite complicated. For example, Kentucky residents can chose to use the federal homestead exemption instead of the modest state exemption.  But in all states you can’t pick and choose between the various federal and state exemptions. Section 522(b)(1) of the Bankruptcy Code. If you are in a state where you can use the federal homestead exemption, you can’t use any of the state exemptions that might be better for another category of assets. In the example of Nevada and Florida residents, who have such a large or unlimited homestead exemption, if they use that advantageous state homestead exemption they must use their state’s exemptions even if the federal ones may be better in other property categories.

Also, you can’t move to a new state and immediately claim that state’s generous homestead exemption. You must be “domiciled” in your new state for 730 days, or two years. Section 522(b)(3) of the Bankruptcy Code. 

Finally, your homestead exemption might be limited by a federal cap on the amount you can clam if you bought your home within 1,215 days (3-years and 4 months) before filing bankruptcy. Section 522(p) of the Bankruptcy Code. Effective April 1, 2019 (and for 3 years thereafter), this cap amount is $170,350. This is relevant only if your state homestead exemption is larger than this relatively large amount.

Need Legal Advice

There are other potential complications, depending on your situation. For example, what qualifies as a “homestead” to which you can apply the homestead exemption? What if you’re not on the title but instead buying a home on contract? What about leasehold interests you may have?  What happens if you own the property with your spouse, or with somebody else?

Your homestead exemption situation could well be very straightforward. But it may not be, even when it seems like it is. You need to get legal advice about this. It would be one of the first topics you would cover with your bankruptcy lawyer, and hopefully get reassured about.

Bankruptcy—including Chapter 7—can be a great way to protect present and future equity in your home. But it’s crucial to know for sure which homestead exemption applies to you, and whether it will definitely protect your home.

 

More Bankruptcy Benefits for Your Home

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Besides helping with your mortgage, bankruptcy protects your home against other liens—from judgments, income taxes, and homeowner associations.  


Last week we gave you 7 ways that bankruptcy can either save your home now or protect it going forward. Here are the remaining 8 ways (#8 through #15), mostly involving involuntary liens placed on your home by special creditors.

8. Judgment lien “avoidance”:  

You can get rid of a present judgment lien that’s on your home’s title if it “impairs” your homestead exemption. This means that it “eats into” the equity that is protected by the exemption. Judgment lien avoidance turns a secured debt that you’d have to pay to protect your home into an unsecured one. See Section 522(f)(A) of the U.S. Bankruptcy Code.  You could then usually write off (“discharge”) that unsecured debt in a Chapter 7 “straight bankruptcy” case. Or you could pay little or nothing on that debt in a Chapter 13 “adjustment of debts.”  

9. Prevent future judgment liens:  

Bankruptcy stops ongoing or future lawsuits against you. See the “automatic stay” of Section 362(a)(1) and(6) of the Bankruptcy Code. First, ongoing lawsuits are usually frozen in their tracks so they can never turn into judgments. Second, any creditors which have not sued you beforehand usually can’t ever do so (with some rare exceptions). So they can’t get a judgment, and can’t ever record a judgment lien on your home. Since not all judgment liens can necessarily get “avoided” under #8 above, it can be very important to file bankruptcy with your bankruptcy lawyer before a creditor gets a judgment.

10. Prevent upcoming income tax liens by discharging the tax debt: 

Similarly, in many situations bankruptcy prevents the IRS or your state from recording an income tax lien against your home. Section 362(a)(4 and 5). Under either Chapter 7 or 13 you can discharge older and otherwise qualifying tax debts. During the bankruptcy case the IRS/state can’t record a tax lien. And it can’t do so afterwards because the tax debt no longer exists. So, your bankruptcy filing prevented the tax from being secured against your home, which would’ve created serious disadvantages for you. As a result it’s highly preferable to file bankruptcy before a tax lien gets recorded.

11. Prevent upcoming income tax liens by paying off the tax debt:  

If the tax debt is newer or otherwise doesn’t qualify for discharge, pay the tax through Chapter 13 filed through your bankruptcy lawyer. Section 1322(a)(2). You pay the tax based on your realistic budget instead of the IRS/state’s imposed one. You can delay paying on the tax while you pay more important debts (such as to catch up on your mortgage). You don’t pay ongoing interest and penalties (since the debt is unsecured). Again, during the case the IRS/state can’t record a tax lien. And it can’t afterwards because by then you’ll have paid off the tax. You’d have prevented IRS/state from gaining the significant advantage against you of a recorded tax lien.

12. Prevent or address a child/spousal support lien against your home:  

Discharge your other debts with a Chapter 7 or 13 case so that you don’t fall behind on support payments. Or if you’re already behind, catch up on your support obligations with a Chapter 13 payment plan. As long as you pay as you’ve agreed, no new support lien can be imposed on your home. And your ex-spouse or support enforcement agency can’t foreclose on any pre-existing support lien. Your home is protected while you catch up.

13. Protect your home from your homeowners’ association:

If you’re get behind on homeowner association dues and/or assessments, your HOA gains tremendous power over you. You can regain the upper hand by filing a Chapter 13 case. You have to pay the back dues or assessment(s) if you want to keep your home. But you have as much as 5 years to catch up through a Chapter 13 payment plan. Throughout that time the HOA can’t foreclose or take other collection action, as long as you’re paying your plan.

14. Buy time to sell your home:

In many different situations, bankruptcy gives you more time to sell a home. You may need more time to get it ready for sale, or may want to move later for personal reasons. Chapter 7 usually delays a mortgage foreclosure, or similar actions against your home by other lienholders, for a few weeks or months through Chapter 7. You can likely get much more time to sell, sometimes as long as 5 years, through Chapter 13.

15. Resolve accounting disputes with your mortgage lender:

If you fall behind on your mortgage, it can be shockingly difficult to get on the same page with your lender about how much you owe. This is especially true if you have a history of being behind over an extended period. This accounting confusion has been a serious problem for millions of homeowners over the last decade or two. So, in 2011 a new procedure was created (mostly for Chapter 13) to efficiently resolve such disputes. See Rule 3002.1 of the Federal Rules of Bankruptcy Procedure. It’s a very handy tool when you’re trying to save your home and your lender is not cooperating.

 

Bankruptcy’s Many Benefits for Your Home

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Bankruptcy can save and protect your home in many different ways. One of these may be just what you need. Or you may use them in combination.   

 

We’ve got 15 distinct ways that bankruptcy can either save your home now or protect it in the near future. Here are the first 7—the remaining 8 we’ll give you next time:

1. Home equity protection:

 You can just about always protect any equity you have in your home through bankruptcy. You can do so through Chapter 7 “straight bankruptcy” if the amount of equity is no more than your applicable homestead exemption. (This is based on state or federal law, depending on your state.) Even if you have no equity in your home now, bankruptcy can protect equity that you build up going forward. See Section 522(b)(2), (b)(3), and (d)(1) of the U.S. Bankruptcy Code.

2. Home equity larger than homestead exemption: 

If your equity is larger your applicable exemption, then a Chapter 13 “adjustment of debts” can usually protect it better than Chapter 7. That’s because it give more time and a better way to preserve that equity while under bankruptcy protection. See Section 1325(a)(4) of the Bankruptcy Code.

3. Free up cash flow for your mortgage payments:

If you’re not behind on your mortgage, write off your other debts to have money for your monthly mortgage payments. Talk with your bankruptcy lawyer to find out which debts will likely go away, and which may not. He or she will also help you create a post-bankruptcy budget. Hopefully it will showing that you can afford the mortgage after getting rid of the other debts. See Sections 727 and 1328 of the Bankruptcy Code.

4. Catch up with a forbearance agreement:  

If you’re not far behind on your mortgage, write off your other debts through Chapter 7. Then catch up on your missed mortgage payments through a forbearance agreement with your mortgage holder. Instead of paying other debts, put your money into saving your home. A forbearance agreement gives you a specific amount of time to get current, usually through designated extra payments.  

5. More time to catch up:

Chapter 13 gives you 3 to 5 years to catch up on your mortgage. This is generally much more time than you’d get through a forbearance agreement. With the catch-up payments spread out longer, they’re much smaller, and so more affordable. Throughout those catch-up years your mortgage lender can’t take collection or foreclosure action as long as you follow the agreed payment plan. See Sections 1322(b)(2) and 362(a)(4) and (5) of the Bankruptcy Code.

6. Prevent property tax foreclosure:

Pay back property taxes through a Chapter 13 payment plan. Again, you have 3 to 5 years to catch up, and protection from tax foreclosure in the meantime. Plus your budget will includes money for future property taxes so you won’t need to worry about that going forward.

7. “Strip” a junior mortgage.

“Strip” a second or third mortgage from your home’s title, thus greatly reducing your overall mortgage debt. If you meet the required conditions, you can stop paying the second and/or third mortgage payments. You’ll likely end up paying none or only a small part of a “stripped” mortgage balance. As a result the total debt on your home will get closer to the home’s value. You’d be able to create future equity faster as the home’s value increases in the future.

 

Cramdown on Furniture and Other Personal Property Debts

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Cramdown lowers vehicle loan payments and the total paid on the loan. But you can also get similar benefits on other personal property debts. 


 

Our last 4 blog posts have been about Chapter 13 cramdown of vehicle loans. For most people filing a consumer bankruptcy case, their vehicle loan is their largest and most important personal property debt.

But cramdown can also apply to debts secured by personal property other than your vehicle. Some examples are furniture and appliance loans, secured credit cards, and pawnbroker loans.  Cramdown on such debts can reduce both monthly payments and the total you pay on the debt. Often both your immediate savings and the long-term savings are significant. If you’re behind on payments you’d likely not need to catch up.  

If the secured debt is large enough, or if keeping the collateral is important enough, the opportunity to cram down the debt may be reason enough to file under Chapter 13 “adjustment of debts” instead of Chapter 7 “straight bankruptcy.” Or if you have decided on Chapter 13 for other reasons, the savings on your non-vehicle personal property loan(s) will likely help you have a successful Chapter 13 case.

Cramdown Divides a Debt into the Secured and Unsecured Portions

Bankruptcy law divides an undersecured debt into secured and unsecured portions. See Section 506(a)(1) of the U.S. Bankruptcy Code. (“Undersecured” means that the collateral securing a debt is worth less than the amount of the debt it is securing.)

Chapter 13 cramdown allows you to create new payment terms based on the secured portion only. Besides the reduced amount of principal being paid, the payments usually stretch out over a longer period. The interest rate is often also reduced.  These all usually result in a reduction in the monthly payment.

Then you pay the remaining unsecured portion usually only to the extent that you can afford to, if at all. That generally reduces the amount you pay before you own the collateral free and clear at the end of your case.

For Example

Assume you bought bedroom and living room furniture a year ago for you and your kids. You had moved to a new job and thought you could easily afford the monthly payments. You financed the entire $5,000 price of the furniture, at 15% interest, and monthly payments of $200. The first payment was not due until 6 months later.

But now a year from the purchase, the income from your new job has not turned out to be as much as you’d expected. Plus some old income tax debts have caught up with you. So now you’re filing a Chapter 13 case.

What happens to the furniture debt? It’s an undersecured one, with the depreciated furniture now worth only $2,500 while the debt is still $4,500. (That high balance is because of the 6 months of no payments and then irregular payments the following 6 months.)

You’d pay the $2,500 secured portion of the debt over the 36 months of the Chapter 13 payment plan. The annual interest rate would be lowered to around 5%. The resulting monthly payment is only $75 per month.

The remaining $2,500 unsecured portion of the furniture loan would be lumped in with your other general unsecured debts. You’d pay it only to the extent that you had money left over during your payment plan after paying your other more important debts (such as your unpaid income taxes).

So here’s the end result. Without bankruptcy cramdown, you’d have to pay the $4,500 balance plus about $1,000 of interest, a total of about $5,500. With Chapter 13 cramdown, you’d pay $2,500, plus only about $200 of interest, resulting in a total of as little as $2,700. (This assumes paying nothing on the unsecured portion.)

Just as importantly, paying only $75 per month instead of $200 would ease up on your cash flow. That would give you crucial money each month for either necessary living expenses or high-priority debt—such as taxes). This could make possible for you to meet your Chapter 13 goals—such as paying off the taxes you must pay.

Cramdown Timing Condition on “Any Other Thing of Value”

There is one timing condition related to personal property debts secured by other than a “motor vehicle.” If you bought “any other thing of value,” cramdown is not available for 1 year after its purchase. Section 1325(a)(5) of the Bankruptcy Code, and the “hanging paragraph” referring to that subsection, found right below Section 1325(a)(9).  Cramdown is available after that 1-year period has passed.

 

An Example of Money Saved through Vehicle Loan Cramdown

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Here’s an example of vehicle loan cramdown that shows how you can reduce your vehicle payments and be free and clear after paying less. 

 

Our last 3 blog posts have been about Chapter 13 cramdown of a vehicle loan. Cramdown can reduce your loan’s monthly payments, its interest rate, and the total you pay for your vehicle. Often you end up saving a lot both monthly and on the total paid. 

The last three blog posts introduced how cramdown works, how to qualify for it, and how you don’t have to catch up on late payments. But like anything, explaining a bunch of rules only goes so far. Showing how the rules actually get applied can be the best way to make sense of a complicated concept like cramdown. A good example is like a picture: it’s worth a thousand words.

So today, how does cramdown work in real life?

The Facts of Our Example

Let’s say you are a payment behind on your vehicle loan. You’re about to miss a second payment, and you’re feeling desperate. You have made making your vehicle payments a priority but you have other debts that are putting intense pressure on you. Your vehicle is absolutely essential in your life so you know you have to do something.  

You know that to keep your vehicle you have to either get rid of or greatly reduce your other debts. Those other debts are medical bills and unsecured credit cards, all together totaling $75,000. You’re considering either Chapter 7 to write off those other debts or Chapter 13 to greatly reduce those debts.

Assume you bought your vehicle 3 years ago, it’s worth $9,000, but you still owe $15,000 on it. The contractual monthly payments are $550. Your budget, allowing for reasonable amounts for your living expenses, shows that you can afford to pay a total of $350 per month on all of your debts, including the vehicle loan.

Chapter 7 Doesn’t Help Enough Here

You understand that a Chapter 7 case would most likely write off (“discharge”) your entire $75,000 of unsecured debts. But even after that you’d really struggle to pay the $550 monthly vehicle payments. Plus you’d almost for sure have to catch up quickly on the $1,100 in late payments (2 times $550).  

How Chapter 13 Cramdown Helps More

Cramdown essentially allows you to re-write your vehicle loan based on the fair market value of your vehicle.

Cramdown helps you more financially the more that you owe on your vehicle than it’s worth. Plus it’s usually available only if your loan is more than 910 days old—about 2 and half years. (See the unnumbered “hanging paragraph” right after Section 1325(a)(9) of the U.S. Bankruptcy Code.) You qualify in our example because you bought your vehicle 3 years ago. (See exceptions to the 910-day qualification rule in our second-to-last blog post.)

Cramdown would rewrite your vehicle loan based on the $9,000 your vehicle is worth. The term of cramdown payments lasts between 36 to 60 months. Your interest rate is often reduced as well, depending on your contract interest rate. Plus, you don’t have to catch up on any missed payment.

This is contrast to Chapter 7, where almost always you have to accept all the contractual terms of the loan if you want to keep your vehicle. That includes catching up very quickly on any missed payments.  

Paying Less through Cramdown

What would be your monthly payment to pay off the $9,000 value of your car?  (That’s the secured portion of the $15,000 total vehicle debt.) Assume a 36-month Chapter 13 payment plan—the usual minimum length. Amortizing $9,000 over 36 months at 5% interest yields a monthly payment of about $270.

We said earlier that you can afford to pay all your debts $350 per month. (That includes the vehicle loan.) So your monthly Chapter 13 plan payment would be $350.  That would cover all your debts.

$350 monthly payments times 36 months equals $12,600 total paid. The vehicle lender would receive $9,000 of that, plus about $700 of interest over the 36 months. The Chapter 13 trustee gets a percentage—let’s say 4% of the total, so $504. Add up those amounts and we’ve accounted for $10,204 of the $12,600 total you’re paying. This leaves $2,396 remaining.

Assume in this example that you paid your bankruptcy lawyer up front. Otherwise part of his or her fee would be paid out of that remaining $2,396. But here all of that $2,396 would go to your pool of general unsecured debts. That includes the $75,000 of medical and credit card debts, plus the $6,000 unsecured portion of the vehicle loan. (That’s the part of the $15,000 total not covered by the vehicle’s value–$15,000 minus $9,000 = $6,000.)  $75,000 + this $6,000 = $81,000 in general unsecured debts.

The $2,396 left over is spread out pro rata to the $81,000 in general unsecured debts. This means that these debts will receive about 3% of the amount due. The unsecured $6,000 portion of the vehicle loan would thus get only about $180 of it paid.

The Final Numbers

Through the Chapter 13 vehicle cramdown in this example, you would pay to your vehicle lender the $9,000 vehicle value, plus about $700 in interest, plus the above $180, a total of about $9,880. You would not have to catch up on the $1,100 in late payments. This is in contrast to paying the $15,000 loan balance, plus likely about $2,000 in interest, or about $17,000. That’s what you would have to do to keep the car outside bankruptcy or under Chapter 7.

Under Chapter 13 your monthly payments on the vehicle would be $270 instead of $550. Your monthly plan payment would be $350—which includes the $270 to your vehicle lender. After 36 months of paying $200 less than you would have paid on your vehicle alone ($350 vs. $550), you would own your vehicle free and clear and would nothing to any of your other creditors.

 

Cramdown Your Vehicle Loan if Behind on Payments

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Vehicle loan cramdown doesn’t just likely reduce your vehicle payments and the total you pay. You’d also not have to catch up on late payments.  

 

Our last two blog posts have been about lowering monthly vehicle loan payments through Chapter 13 cramdown. This also often reduces the total that you pay on the loan until your vehicle is free and clear. Cramdown often even reduces the interest rate you pay. So it usually saves you money both every month and long term.

If you’re behind on your payments there’s an even more immediate benefit. If you qualify for cramdown, you don’t have to catch up on any late payments. This frees up the money immediately for other urgent needs. This is a huge monetary benefit at a time when your cash is likely extremely tight.

On top of this financial benefit, you get the peace of mind that your vehicle won’t be repossessed. Vehicle lenders can be quick to repossess when you fall behind, especially if your payment history has been spotty. It’s great to prevent a repossession, and then not have to scramble to catch up on the missed payments.

Today we show how this works.

Qualifying for Vehicle Loan Cramdown

See our last blog post for an explanation about how to qualify for Chapter 13 vehicle loan cramdown. Basically, the loan has to be more than 910 days (about 2 and a half years) old at the time you file your Chapter 13 “adjustment of debts” case. And the value of your car or truck needs to be less than the amount you owe on it. The more your vehicle is worth less than you owe the more cramdown can help you.

(There are some exceptions to the 910-day rule. For example, if the vehicle was purchased for business use, or if the loan was not for the purchase of the vehicle, there’s no time limit. Again, see our last blog post for the details. Also, see the “hanging paragraph” following Section 506(a)(9) of the federal Bankruptcy Code.)

The Missed Payments Are Unsecured

So now assuming that your vehicle loan qualifies for cramdown, see our second-to-last blog post about how cramdown works. Basically, your Chapter 13 payment plan divides your loan debt into secured and unsecured portions. The secured portion is in the amount that your vehicle is worth. The unsecured portion of the debt is the rest of its balance.

For example, assume you owe $18,000 on a vehicle that is worth $12,000. The secured portion of the loan balance is $12,000 and the unsecured portion is the remaining $6,000.

Your bankruptcy lawyer essentially recalculates the monthly payments based on the $12,000 secured portion. Besides being based on this lower amount to be paid, the monthly payments are often stretched beyond the number of months left on the contract, and the interest rate is often reduced (depending on how high the contract interest rate is). All this usually results in a lower monthly payment, often significantly lower.

The reason you don’t have to catch up on your missed loan payment(s) is that that part of the debt is unsecured. Using the example above, assume your monthly payments are $400, and that you just fell behind on a second month. So you’re behind $800. (And there’s a big risk that the repo man is looking for your vehicle.)

That $800 you’re behind does not affect the value of the vehicle. It’s worth $12,000 whether or not you’re current on the loan or not. That $800 (or whatever amount you’re behind) is part of the unsecured portion of the loan balance. It’s part of the unsecured portion of the debt. It does not affect how much you’re going to be paying each month under the cramdown.

What Does Happen to the Unsecured Missed Payment(s)?

As part of the unsecured portion of the loan balance, it’s put into the pool of your “general unsecured” debts. You pay these in your Chapter 13 plan only to the extent you can during the life of the plan. Other kinds of debts—secured ones and special “priority” ones (like child support and recent income taxes)—get paid before general unsecured debts get paid anything. As a result you often don’t pay the unsecured portion of your vehicle loan much, and sometimes nothing.

When DO You Have to Pay on the Vehicle Loan?

To the extent the general unsecured debts—including the missed payments—get paid, this happens later in your case. Depending on the amount of your secured and priority debts, the unsecured debts often don’t get paid until the final year or even final months of your case.

However, you start paying the secured portion, with the new crammed-down amount—the first month of your plan payments. It’s usually part of the amount that you pay to the Chapter 13 trustee. It’s part of the single plan payment that covers all your debts, based on what you can afford to pay. It’s usually due a month after your bankruptcy lawyer files your proposed plan, and must be paid on time.

Summary

Vehicle loan cramdown doesn’t just save you money, immediately and long-term.  If you’re behind on the monthly payments, cramdown enables you to avoid catching up on those payments. For example, if your vehicle insurance lapsed you could use that money instead to pay to reinstate the insurance. Or, not having to catch up could give you the financial break you need to start paying your Chapter 13 plan payments after filing your case. There are many such circumstances where not having to catch up on missed payments would enable you to keep your vehicle.

 

Qualifying for a Vehicle Loan Cramdown

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To qualify for a Chapter 13 vehicle loan cramdown, mostly your loan must be at least two and a half years old. There are exceptions to this. 

 

Last week’s blog post was about lowering monthly vehicle loan payments through Chapter 13 cramdown. This also often reduces how much you end up paying on the loan, and often even reduces its interest rate. Cramdown usually saves you money both immediately and long term. And you end up owning your vehicle free and clear at the end of your Chapter 13 case.  

Today we get into how to qualify for cramdown.

Qualifying for Cramdown—Timing

You can only do a cramdown if your vehicle loan is more than 910 days old when you file your Chapter 13 case. 910 day is about two and a half years. If you entered into the vehicle loan less than 910 days earlier, you can’t do a cramdown. You can’t reduce the monthly payments or the total amount paid on the loan.

The Bankruptcy Code says that you can’t do a cramdown if “the debt was incurred within the 910-day [period] preceding the date of the filing of the [Chapter 13] petition.” See the “hanging paragraph” following Section 506(a)(9) of the U.S. Bankruptcy Code.

What’s the reason for this 910-day timing condition? It’s a benefit to vehicle lenders. New cars and trucks depreciate fast. You can’t buy a vehicle, have it depreciate quickly for a year or two, and then take advantage of the fact that the vehicle isn’t worth as much as you owe on it. You have to wait two and a half years before you can do this.

Qualifying for Cramdown—910-day Rule Doesn’t Apply

The 910-day rule applies only to vehicle loans that are for the purchase of the vehicle. Under the language of the Bankruptcy Code, the 910-day waiting period only applies when “the creditor has a purchase money security interest securing the debt.” See the same paragraph” following Section 506(a)(9) referred to above.

So a loan used to refinance a vehicle CAN be crammed down without waiting the 910 days. Also, if you borrowed money for some purpose and gave your vehicle as collateral for the loan, you can do a cramdown without waiting.  

This same 910-day waiting period also does not apply to vehicles purchased for business use. The Bankruptcy Code says the 910-day rule only applies if “the collateral for that debt consists of a motor vehicle… acquired for the personal use of the debtor.” See the same paragraph in the Bankruptcy we keep referring to.

There are open questions about both these “purchase money” and “personal use” conditions. For example, “personal use of the debtor” is not defined in the Bankruptcy Code. What about a pickup truck mostly used for operating a business but also used for personal transportation? Or how about a vehicle bought by a parent for the exclusive personal us of an adult child? Is that not the “personal use of the debtor” so that the 910-day rule does not apply?

The answers to these questions may turn on interpretations of the Code language by your local bankruptcy court. Talk with your bankruptcy lawyer about your own particular situation.

Qualifying for Cramdown—Undersecured Vehicle Loan

In case it’s not obvious, cramdown only works if your vehicle is worth less than the balance on your loan. You’re “cramming” the loan amount down to the secured amount of the debt. The more your loan is upside down the more cramdown can help.

If your vehicle is worth the same or more than you owe, there is no opportunity for cramdown. You might gain some other benefits on your vehicle loan from filing a Chapter 13 case, but no cramdown.

And how do you determine what your vehicle is worth for this purpose? For example, do you use “retail value” or “wholesale” or “trade-in” values? Should you use the Kelley or NADA Blue Book values or some other source? Again, these are questions for your bankruptcy lawyer, based on local law and practice.

Qualifying for Cramdown—Only in Chapter 13

Cramdown is not available under Chapter 7 “straight bankruptcy.” You must file a Chapter 13 “adjustment of debts” case. The payment and payoff terms of your cramdown are part of your 3-to-5-year Chapter 13 payment plan. In it you present the value of your vehicle, which indicates the secured part of your loan balance and the remaining unsecured part, and how much you intend to pay on each part.

(Cramdown is also available under Chapter 11 “reorganization,” which is generally used for corporate and other business bankruptcies. Section 1129(b)(2)(A). This blog post focuses instead on consumer oriented Chapter 13. But if you are operating a business or have unusually large debts, Chapter 11 may be an option to consider.)

 

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