If an individual is faced with imminent foreclosure or financial issues regarding real property, bankruptcy through either Chapter 7 or 13, can present significant loss mitigation tools.
Chapter 7 can be extremely effective in relieving the monetary obligation of an individual that no longer wishes to keep his or her home. Often a individual will have attempted to short sale the property prior to considering any bankruptcy option. Those attempts can be unsuccessful, or undesirable inasmuch as the lender may require the individual sign a note to pay any deficiencies on the mortgage as a condition of the sale. Consequently, discharging the mortgage obligation prior to a short sale, puts the homeowner firmly in the driver’s seat when it comes to dealing with lenders in the short sale process.
The options available in Chapter 7, however, pale in comparison to the tools at the disposal of the creditor in a Chapter 13 bankrupcy. Chapter 13 bankruptcy is typically referred to as a “paying” bankruptcy. The essential purpose of the Chapter 13 bankruptcy is to avoid liquidation of assets in a Chapter 7 case and allow the debtor(s)’ to reorganize their affairs. This almost always includes monthly payments for a period between 36 and 60 months composed of the debtor(s)’ disposable monthly income. There is not a “means test” for the purposes of determining eligibility for Chapter 13, rather it is only required that the debtors have income.
It is important to emphasize that the timing of a Chapter 13 petition is everything in relation to distressed real estate. If a foreclosure is in process, a Chapter 13 petition must be filed before the date of the Sheriff’s Sale in order to give the homeowner any shot at retaining his property.
The first (and most common) tool that a Chapter 13 debtor(s) would have at their disposal is the ability to cure arrears on a secured debt. If a homeowner has fallen behind on their payments, has been denied a modification, and wishes to keep their home, the arrears on the mortgage can be divided into 60 payments to cure the deficiency. The debtor would be required to make their current monthly payment and then in addition to that monthly payment, they would pay a portion of the arrears. At the completion of their Chapter 13 plan, the debtor will have made progress on the current balance of the mortgage as well as cured any arrears. The only requirement is that the debtor be able to make the monthly payment required.
Second, an individual that has more than one mortgage on his principal residence may be eligible to “strip off” or remove the lien the property created by junior mortgages. In order to qualify for this relief, a principal residence must have at least two mortgages. The value of the home, as determined by a recent appraisal, has to be at or below the amount owing on the first mortgage. Effectively, this makes any junior mortgage “wholly” unsecured. As a result, the junior mortgage is treated in the Chapter 13 bankruptcy as an unsecured creditor that may only get a fraction of the amount owed to it through the Chapter 13 plan. If the debtor successfully completes their plan and receives a discharge, the lien is removed from the property. The end result is that the Debtor will have been making monthly payments on the first note, while at the same time, they will have removed junior liens, often leaving them with equity in their home.
Third, an individual may be able modify short term mortgages or “balloon payments.” Under section 1322(c)(2) the bankruptcy court is permitted to modify mortgages on which the final payment becomes due during the course of the Chapter 13 Plan. Often, this arises in the instance of balloon payments. As a result, the individual would be able to modify the terms of that mortgage, including payment, interest rate and treat the unsecured portion of the debt as an unsecured creditor in the Chapter 13 Plan, effectively “cramming down” the mortgage to the value of the property.
Fourth, an individual may be able to modify mortgages that are secured by property, including the individual’s principal residence, and any other property under the plain language of 1322(b)(2). It is not uncommon for a mortgage to secure, in addition to the real estate, other items such as household goods, bank accounts, or even other property. Courts will examine whether the agreement provide for security in other collateral that provides an additional interest other than an existing component of that creditor’s security interest in the property. In 2005, congress also added language to 1322(b)(2) that exclude from modification, liens that secure the property and “incidental property.”
Ancillary to a cross collateralized mortgage, a mortgage may be modified in Chapter 13 if it is secured by a multi-family residence or a combined residential and commercial property. The restriction on anti modification claim applies, only to the debtor’s principal residence. Much like the exclusion for debt that is secured by real estate and other property, a multi-unit property can be also be modified.
Finally, a lien may be modified or removed if it is not a “security interest” in real property. A “security interest” in real property is defined as a lien created by agreement. Consequently, a lien created through the judicial process or that is statutory is subject to modification in Chapter 13.
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