Keep Your House With Chapter 13 Bankruptcy

Chapter 13 bankruptcy is a great tool for avoiding foreclosure. If you can stick to your Chapter 13 repayment plan, you may be able to:

Each of these Chapter 13 benefits are described in detail below.

Repay Your Mortgage Arrears Over Time

In many ways, your Chapter 13 bankruptcy repayment plan is like a plan you might negotiate with the mortgage servicer. Either way, you have an opportunity to get your mortgage current over time. Of course, if the only reason you are filing Chapter 13 is to get time to get your mortgage current, and you could get a similar deal from the servicer, you'll be better off not filing for bankruptcy, at least as far as your credit score is concerned.

Part of the problem in workouts with a mortgage servicer is that servicers typically add on a wide variety of fees and costs, which make it difficult for the homeowner to reinstate the mortgage. In Chapter 13 bankruptcy, you can challenge the validity of these fees and costs on a variety of grounds.

It's important to understand that Chapter 13 bankruptcy works to keep your house only if you have enough income to make both your current payment and pay off a portion of your arrears each month (plus costs and fees). And you must propose a plan showing not only that you can make plan payments but also that you can keep current on all your other reasonable and necessary monthly expenses, such as utilities, transportation, car note, insurance, and the like. Further—and this is a deal-breaker for some would-be Chapter 13 filers—you must pay some types of debts in full during the course of the plan. For example, if you owe recent back taxes, the court won't approve your repayment plan unless it shows that you can pay off the taxes in full while your plan is in effect.

Finally, your plan must provide for a payment to the trustee of roughly 10% of the amount of all payments you make to creditors through the repayment plan. This can be another deal-breaker if, for example, you are forced to pay your mortgage through your plan rather than directly to the lender outside of the plan. Unfortunately, there is no uniform nationwide rule on this subject—the courts are split on whether or not the trustee can force you to pay your mortgage through the plan.

Make Your Mortgage More Affordable by Eliminating Other Debts

Americans are up to their eyeballs in debt. It's not uncommon for me to see clients of moderate means who owe credit card debt exceeding $50,000. If you are looking to save your house, and Chapter 13 bankruptcy might get the job done, chances are great that you'll also greatly reduce, if not eliminate, your debt load. Chapter 13 gives you three to five years not only to work out your mortgage problems but also to deal with your unsecured debt (debt not secured by collateral) once and for all.

To eliminate credit card and other unsecured debt in Chapter 13 bankruptcy, you must be willing to commit all of your dispos­able income to repaying as much of the debt as you can (taking into account that you must also pay down other debts, such as mortgage arrears or recent back taxes) over a three- to five-year period. Any unsecured debt that remains at the end of your plan is discharged (canceled), unless it is one of the types of debt that survives bankruptcy, such as child support or student loans.

Disposable income is computed in two entirely different ways, depending on whether your income is above or below your state's median income, and on which judge you end up with. For the vast majority of Chapter 13 bankruptcy filers, disposable income is the income you have left over every month after taxes and other mandatory deductions are subtracted from your wages, you pay necessary living expenses, and you make payments on your car notes and mortgages.

If your household income is higher than the median in your state for a household of your size, you must propose a five-year plan. Your household consists of all people who are living as one economic unit, regardless of relationships and age. Usually this means people who are living under one roof, but not always. Someone who is living apart but freely shares income with the rest of your household could still be a member of the household. For example, a person on active duty who isn't living with you except when on leave would be a member of your household.

Your household disposable income will be partially computed on the basis of IRS expense tables that may or may not match your actual expenses. Also, your disposable income will likely be based on what you earned the past six months, not necessarily on what you are earning now. In other words, the court may rule that you have disposable income even when in fact you don't. Weird? You bet, and many commentators, including bankruptcy judges, have said so. Nonetheless, this is the result Congress apparently intended in its landmark bankruptcy legislation of 2005.

If your household's income is lower than the median income for a similarly sized household in your state, you can propose a three-year repayment plan. However, you can request that the court approve a five-year plan if you need the extra time to meet your payment obligations. For example, say you must pay unsecured creditors $25,000 under your plan. If your plan lasts for three years, you would have to pay $692 a month (plus certain administrative expenses). With a five-year plan, you would pay only $411 a month.

To determine whether you are a high-income or low-income filer, you first compute the average monthly gross income you received from all sources, taxable or not (except for funds received under the Social Security Act) during the six months that immediately precede the month in which you will be filing for bankruptcy. You then multiply that figure by 12 and compare the result with your state's median income.

Get free help online. You can use http://www.legalconsumer.com/ to help you make these calculations and comparisons. The median income figures change at least once a year.

It's important to know that you can propose a Chapter 13 plan even if you have very little disposable income to pay down your unsecured debt, and even if you pay off only a small fraction of that debt.

Nothing in the bankruptcy law requires a minimum percent­age of repayment; it's left up to the judge. Some bankruptcy judges will accept plans that pay even a smaller percentage of unsecured debt than shown in these examples. In fact, some plans have been approved that pay 1% or even less. But some judges won't approve a plan unless it provides for repaying a certain higher minimum percentage of debt.

Ask the Court to Reduce ("Cram Down") Certain Secured Debts

Chapter 13 bankruptcy judges can reduce (cram down) certain secured debts to the market value of the collateral that secures the debt. They can also reduce interest rates to the going rate in bankruptcy cases (roughly 1.5 points above the prime rate). If you can get the judge to reduce your payments on a secured debt, you will have more money to pay towards your mortgage—and a better shot at proposing a Chapter 13 plan that the court will confirm.

A cramdown is usually available only for:

• cars bought at least 30 months before you file for bankruptcy
• other personal property items (furniture, jewelry, and computers) bought at least one year before filing
• rental on vacation homes (but not your primary residence)
• loans on mobile homes that your state classifies as personal property (not real estate), and
• loans secured by your home that you can pay off within five years.

Contest the Foreclosure

You can fight a foreclosure whether or not you file for bank­ruptcy. But if you file for Chapter 13 bankruptcy, you can ask the bankruptcy court to decide whether the facts upon which a proposed foreclosure is based are erroneous.

For example, suppose you contest the foreclosure on the ground that your mortgage servicer failed to properly credit your payments. A court decision in your favor on this point would eliminate the basis for the foreclosure should you later drop your Chapter 13 case or convert it to a Chapter 7 bank­ruptcy. (Remember, you aren't confronted with the fore­closure itself while you are in Chapter 13 bankruptcy unless the lender seeks and gets court permission to lift the stay.) Unlike some state courts, the bankruptcy court is a comparatively friendly forum for homeowners challenging foreclosures.

Turn a Second or Third Mortgage Into an Unsecured Debt

If you're like many homeowners, your home is encumbered with a first mortgage, a second mortgage (often used for the down payment in an 80-20 financing arrangement), and even a third mortgage (maybe in the form of a home equity line of credit). Most likely, the holder of the first mortgage is pushing the foreclosure. But if you have fallen behind on your first mortgage, you are probably behind on your second and third mortgages as well. Would it help you keep your house if you no longer had to pay the second or third mortgage? You know the answer: Lightening your overall mortgage debt load could only help you meet your first mortgage obligation.

One of the great features of Chapter 13 bankruptcy is that in many (but not all) bankruptcy courts you can get rid of (strip off) all mortgages that aren't secured by your home's value. Let's say that you have a first mortgage of $300,000, a second mortgage of $75,000, and $50,000 out on a home equity line of credit. Presumably, the value of your home when you took on these debts was at least equal to the total value of the mortgages, or $425,000. But if the house is now worth less than $300,000, as a practical matter the house no longer secures the second and third mortgages. That is, if the house were sold, there would be nothing left for the second or third mortgage holders.

If your second and third mortgages were considered secured debts, your Chapter 13 plan would have to provide for you to keep current on them. However, when they are stripped off, they are reclassified as unsecured debts. This means you have to repay only a portion of them—just like your other unsecured debts. And as explained earlier, the amount of your disposable income, not the amount of the debt, determines how much of the unsecured debt you must repay.

This also means that under your Chapter 13 plan you won't have to make up payments missed on your second or third mortgages. And because you're no longer making current payments on the second or third mortgage, the total amount you pay each month will be reduced by a considerable amount.

Find out whether your court will let you get rid of liens. Although eliminating a lien when there is no equity to secure it is logical and permitted by many courts, some courts refuse to allow it. They reason that stripping a lien from a house is tantamount to modifying a residential mortgage, something that is not allowed by the bankruptcy laws. At some point, this issue is likely to be resolved by higher federal appellate courts. For now, if this is a major reason you are considering Chapter 13 bankruptcy, you need to know how your court would address it. Contact a local experienced bankruptcy attorney to get that information.