Almost a year ago, when problems in the housing market began making the front page, the Wall Street Journal ran a story about Chapter 13 bankruptcy, saying that “If people knew they had the Chapter 13 option, a lot of people would save their house”. The Journal correctly explained that “the people most likely to benefit from Chapter 13 are those suffering a temporary setback, who expect to be able to cover their mortgage payments in the future.” Around that time, I was just beginning my bankruptcy blog, so I quoted the WSJ article and added something I thought was very important to stress to people who were considering filing bankruptcy. There’s no one right decision when it comes to keeping a home or letting it go. It depends on the situation (see Keeping Home Sweet Home – It Depends!).
(Before I review how bankruptcy relates to foreclosure, and foreclosure to bankruptcy, I absolutely must put in a reminder about timing. That’s because, even when folks have done the right thing by seeking out legal advice, and even though I have almost twenty-five years’ experience working with foreclosures and bankruptcies, it might be too late. Unless those clients have come to me before certain deadlines kick in, there are some kinds of help that simply won’t be available – no matter who’s helping them.)
If a Chapter 13 bankruptcy is filed properly and in time, (assuming the debtor qualifies) it can, as The Bankruptcy Handbook puts it, “stop foreclosure dead in its tracks”. That’s because, under a Chapter 13 reorganization plan, the debtor gets three to five years to pay the arrears on the mortgage. (During those three to five years, though, all the regular mortgage payments will need to be made as each comes due.)
When I began my bankruptcy law practice almost twenty-five years ago, it was typical for people, same as today, to have mortgages on their homes. But, what I find is very different today is, almost all my bankruptcy clients have two mortgages, a first and a second mortgage. And, as you’ll see in a minute, that could turn out to be very important in planning to save a home using a Chapter 13!
Without getting very technical, I can just explain that bankruptcy law treats unsecured loans and secured loans differently. When my clients originally took out their mortgages, both their first and the second mortgages were secured, with the first mortgage lender having priority over the second mortgage lender.
Nowadays, it’s very common for homes to be completely “upside down”. That means the house itself has a market value that’s less than the first mortgage, and certainly far less than the first and second mortgage amounts combined…(Are you with me so far?)
Suppose a debtor purchased a home a number of years ago when the price of that home was $300,000, taking out a first mortgage from Lender A for $260,000, and a second mortgage, from Lender B, for $30,000. Today, the market value of that house could very well have dropped to $250,000 or even less. The second mortgage now has absolutely no security backing up the loan, and even the first mortgage lender isn’t fully protected.
Well, in that situation, it’s quite possible the second mortgage could be treated as an unsecured debt, equivalent to a credit card debt. This means the bankruptcy court has the power to totally wipe away the second mortgage, while allowing the debtor to remain in the family home. If the monthly mortgage payment now becomes affordable, that could mean the debtor is able to save his family’s home from foreclosure.
Chapter 13’s not for everyone. But, to some people, saving their home – it means the world!