Most people would welcome the opportunity to reduce the balance of their mortgages. If certain conditions are met, a Chapter 13 bankruptcy allows you to do just that through a mortgage "cramdown." Notably, though, you cannot cram down the mortgage on a home you use as your principal residence. (To see options for dealing with a residential mortgage in Chapter 13, check out Your Home and Mortgage in Chapter 13 Bankruptcy).
Read on to find out what a cramdown is, how it works, and which properties you can use it on.
A mortgage cramdown allows you to reduce the principal balance of your mortgage to the value of your real estate. It may also allow you to reduce your mortgage interest rate.
You can use a Chapter 13 bankruptcy to cram down the mortgages on your investment properties. Investment property generally means any property other than your principal place of residence such as rental or commercial properties. You cannot use a mortgage cramdown to reduce the balance of your mortgages on your principal residence. However, you may still be able to get rid of your second mortgage on your principal residence in Chapter 13 bankruptcy through a process called lien stripping.
Many people buy real estate believing that property values will increase over time. This is not always true, however, especially in the current economic climate. If your property has declined in value faster than you have paid down your mortgage, you may be “upside down” on the property -- which means your mortgage balance is greater than the value of the house.
For example, say you bought an investment property for $300,000. Later, the value drops to $150,000 although you still owe $250,000 on the mortgage. In this situation you are upside down on the mortgage.
This is where a mortgage cramdown may be able to help you. You can cram your mortgage down to $150,000 (the current value of the property) through your Chapter 13 plan and pay that to your mortgage lender instead of the entire $250,000. The remaining $100,000 becomes unsecured debt and is treated as such in your bankruptcy -- you'll likely pay a small portion of that amount through your plan and the rest will be discharged (wiped out) at the completion of your plan.
By cramming down your investment property mortgage, you may enjoy additional benefits.
Possible reduced interest rate. When you cram down a mortgage in your Chapter 13 plan, the interest rate you must pay to the mortgage lender is determined by your local bankruptcy court. This is usually set at the prime rate plus a small percentage. This may be lower than rate on your mortgage note.
No liability for a deficiency. Usually, when a mortgage lender forecloses on your investment property, you are liable for any deficiency balance (mortgage balance less the foreclosure sale proceeds to lender) in most states. However, if you cram down the loan through a Chapter 13 bankruptcy, and the property is later foreclosed on, you are not liable for the amount that has become unsecured debt (which is generally equal to the deficiency.)
Most courts require that you pay off the balance of your crammed down mortgage during your Chapter 13 repayment period, which is between three and five years. This means that your plan payments will likely be very large or that you must tack a balloon payment onto the end of your plan. Courts won't confirm a Chapter 13 plan with a balloon payment, however, unless you can demonstrate that you have the means to make the payment down the line (for example, you can sell other property and use the proceeds to make the balloon payment). This limitation bars many people from cramming down their investment property mortgages.
Learn more about cramdowns in our topic area on Reducing Loans and Non-Residential Mortgages in Chapter 13 Bankruptcy.