Keep Your House With Chapter 13 Bankruptcy

By , Attorney · UC Law San Francisco

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:

  • repay missed mortgage payments (your mortgage arrears) over the life of the repayment plan, typically three to five years
  • pay a fraction (or sometimes, nothing) of your unsecured debts during the plan period and probably eliminate these other debts entirely when you complete your plan, freeing up money to pay your mortgage
  • ask the court to reduce ("cram down") certain secured debts to the value of the collateral (for instance, reduce your $20,000 car note to the actual value of the car, say $12,000, reducing your monthly payments)
  • contest the legality of the proposed foreclosure in the bankruptcy court
  • contest any claims for costs and fees that are added to the missed payments you'll repay as part of your plan (these costs are commonly made erroneously), and
  • get rid of (strip off) liens on your home created by second and third mortgages, as long as they are wholly unsecured by your home (that is, if your home were sold the proceeds would be insufficient to pay back any portion of the lien).

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.

EXAMPLE: Freddie owes $3,600 in missed mortgage payments. He receives a notice of default that gives him a month to pay up or lose his house. His mortgage servicer refuses to work with him because of a previous notice of default—the lender doesn't think he's a good credit risk.

Freddie had fallen behind on his mortgage because he was laid off, but now he's working again. If he files for Chapter 13 bankruptcy and gives up one of the cars he's making payments on, he'll be able to afford a repayment plan, under which he will stay current on his mortgage and also make up the arrears over three years. He proposes to pay down the arrears at the rate of $120 a month: $100 for the debt plus $20 a month for the trustee's fee.

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.

EXAMPLE: Marcia proposes a three-year Chapter 13 repay­ment plan, under which she will pay her $2,000 monthly mortgage directly to the lender. On the basis of her disposable income (roughly, the difference between her income and her necessary expenses), she also proposes to pay the arrears she owes on the mortgage and a percent­age of her unsecured debt to the trustee at a rate of $139 a month ($5,000 over the life of the plan). Under this proposal, the trustee will be paid a fee of $14 from every monthly payment (36 in all).

Unfortunately, the trustee objects to Marcia's plan, arguing that she should pay the current mortgage (as well as the arrears) through the plan. The court allows the trustee to require her to pay the mortgage through the plan. That means Marcia must amend her plan to pay an additional $200 a month (10% of the $2,000 monthly mortgage payment) as the trustee's fee. Because Marcia doesn't have enough disposable income to pay another $200 every month, she is unable to propose a feasible amended 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.

EXAMPLE: Terry's net income, after mandatory deductions, is $4,000 a month. Out of this must come a mortgage payment of $1,500, a car payment of $500, and $1,800 for utilities, food, transportation, insurance, medical prescriptions, and other regular living expenses. The $200 that's left over each month is Terry's disposable income.

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.

EXAMPLE: Justin plans to file for Chapter 13 bankruptcy in June. He lives in California and has four people in his household. He will have to compute his average gross ­income from all sources (except Social Security) for December of the previous year through May of the current one. It comes out to $6,000 a month. He multiplies this figure by 12 for an annual figure of $72,000. Because the median income for a California family of four is more than $76,000, he qualifies as a low-income filer.

Get free help online. You can use 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.

EXAMPLE 1: Rubin owes $36,000 in unsecured debt, con­sisting of credit cards and personal loans. His income is below the median for his state, and he has $200 dis­posable income left each month over after paying all his living expenses and monthly contractual debt (a $1,000 mortgage and a $450 car loan). Rubin successfully proposes a plan that will pay his unsecured creditors $200 a month for 36 months. It comes to a total of $7,200, which is 20% of his unsecured debt. The rest will be discharged if he completes the plan.

EXAMPLE 2: Lynn also has $200 of disposable income each month. She has both unsecured debts and $3,000 in missed mortgage payments. In her Chapter 13 repayment plan, a portion of her disposable income will be used to make up some missed payments, and the rest will go to her unsecured debt. For example, if she has a three-year plan, $83 a month would go for the missed payments, and the other $117 would go to repay 12% of the unsecured debts.

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.

EXAMPLE: Allison bought a new car for $24,000, taking a seven-year note for $38,000 (including the principal and interest), with monthly payments of $475. Three years later, when Allison files for Chapter 13 bankruptcy, she still owes $24,000, even though the car's market value has fallen to $14,000.

As part of her Chapter 13 plan, Allison asks that the note be crammed down to $14,000 and that the interest rate on her loan be reduced to 4%, the approximate going rate in bankruptcy cases. The court approves this cramdown, and Allison's monthly car payment is cut roughly in half.

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.

EXAMPLE: Sean files for Chapter 13 bankruptcy and proposes a three-year plan to make up his missed mortgage payments. He also owes $60,000 in credit card debt and has disposable income of $300 a month. His house's value is $250,000. He owes $275,000 on his first mortgage, $30,000 on the second, and $15,000 on a home equity loan.

Because his house's value has fallen below what he owes on the first mortgage, there is no equity left to secure the second mortgage or home equity loan. So his Chapter 13 plan would classify these two formerly secured debts as unsecured. When they're added to the $60,000 in credit card debt, he's got a grand total of $105,000 unsecured debt. Because all he has is $300 per month in disposable income, his plan would repay a little more than 10% of his unsecured debt—including a little over 10% of his formerly secured second and third mortgage debt.

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.

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