We see situations where people whose incomes have been cut will forego paying the second mortgage while staying current with the first. When they are able to resume payments on the second mortgage balance but the mortgage company is unwilling to modify their mortgage so that they can catch up on the missed payments, Chapter 13 is a court-supervised way to accomplish the goal.

(Mortgages are actually called “deeds of trust” in North Carolina, but we’ll use the term mortgages here.)

We have dealt using Chapter 13 to help homeowners catch up on missed mortgage payments (first and second mortgage payments) in other posts.

Three options in Chapter 13 for a second mortgage

There are three options for a second mortgage in a Chapter 13, where the debtor is current on the first mortgage:

1. Get caught up on the second mortgage through bankruptcy plan payments. The second mortgage arrearage, as of the date of the filing of the bankruptcy petition, is paid back in full through the plan payments, over time.

Chapter 13 cases typically involve proposing a plan to pay back creditors over sixty monthly payments (five years); a debtor can propose a plan to pay what’s owed as of the date of the bankruptcy filing back, in sixty monthly installments. At the same time, the debtor must make each current mortgage payment.

For example, if a Chapter 13 case is filed on October 1, 2011, and as of that date, the borrower is past due on a total of $12,000.00 in second mortgage payments, then the debtor can, through a Chapter 13 bankruptcy case, pay the $12,000.00 back over sixty months, but must at the same time pay each and every month all mortgage payments (first and second). Thus, in October, the debtor must pay his or her October 2011 first and second mortgage payment PLUS the Chapter 13 payment, a portion of which goes to paying the pre-petition second mortgage arrearage. This goes on for sixty months (the life of the Chapter 13 case).

2. Surrender the property and discharge the debt that is secured by it.  Sometimes, borrowers either simply cannot afford to pay second mortgage arrearages in a Chapter 13 case (see above) while at the same time remaining current on their mortgages, or decide not to make those payments because the debt exceeds the value of the property (it is “underwater”). These situations often cause a borrower to decide to give up (surrender) the property in a bankruptcy case and discharge the mortgage debts.

Depending on the borrower’s overall financial situation, the borrower may qualify for Chapter 7, discharging the debt and making no payments to the mortgage lender – or, be limited to a Chapter 13, discharging the debt and paying a fraction of what’s owed to the mortgage lender (the payment depends on the debtor’s individual financial circumstances).

The mortgage lenders will eventually foreclose on the surrendered property, and their recovery is limited to (a) the proceeds realized from the foreclosure sale and (b) any payment through the Chapter 13 plan. Because the property is being surrendered as part of the bankruptcy case, the mortgage debts are treated as unsecured (because the house goes through foreclosure) and are paid the same amount as credit cards, medical bills, and other unsecured debt, according to what the plan proposes that unsecured creditors be paid (generally less than 10 cents on the dollar, but the plan payment depends entirely on each borrower’s financial situation).

3. Strip the second mortgage through an adversary proceeding in the Chapter 13 case.   This is a complex subject that my law partner, Rick Mitchell, covered thoroughly in another post.

Evaluating the various ways of dealing with mortgaged real property is too complex for a blog post. This one is designed to give you hope for a solution that is monitored by the federal bankruptcy courts and that your mortgage lenders will probably not tell you about. Call a qualified bankruptcy attorney.

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Does this mean that there is nothing that homeowners can do to try to save their homes?  Unfortunately, in most instances the answer is yes.

However, there is a way that some homeowners can protect their homes by the use of something called lien stripping.

Lien stripping: great option for the few who can qualify

Unfortunately, lien stripping works only in a narrow set of circumstances.  There are three elements that must be present.

• First, there must be a first and second mortgage on the home.  A home equity line of credit (“HELOC”) is one form of second mortgage.
• Second, the value of the home must be such that there is no equity to secure the second mortgage.
• Third, if the homeowner did not have to pay the second mortgage payment, he or she would be able to afford the home.

If these three elements are present the homeowner may file a Chapter 13 bankruptcy reorganization and propose a plan that strips the second mortgage.  Stripping means that the second mortgage is removed as a mortgage lien on the home, and the second mortgage lien debt becomes a general unsecured debt that can be paid pennies on the dollar.

John and Jane Doe strip their lien

An example of lien stripping involves John and Jane Doe.  The Does have a home with a value of $175,000.  They have a first mortgage lien to Number One Lender Bank of $180,000 with a payment of $1,500 per month.  They have a second mortgage lien of $50,000 to HELOC Bank with a payment of $350 per month that is an interest only payment.  The Does can afford the first mortgage payment, but they cannot afford both the first mortgage and second mortgage payments.  In addition, they realize that the property is worth far less than what is owed on it, and since the loan with HELOC Bank is interest only, they are making little if any progress toward creating any equity in the home.

In this situation, the Does can file a Chapter 13 reorganization case and propose to strip HELOC Bank’s second mortgage lien.  The debt owed to HELOC Bank is treated in the plan as a general unsecured creditor along with other general unsecured creditors such as credit cards, medical bills and the like.

The general unsecured creditors are paid based on the financial ability of the Does to make payments and in many instances these payments can be five percent or less of the debt, with no interest, over a period of up to five years.  At the end of the plan, the bankruptcy court will enter an order stating that the HELOC Bank’s second mortgage lien no longer encumbers the Does’ home.

Who cannot use lien stripping

Simply having a second mortgage will not help a number of homeowners.  In order to have the ability to strip a second or third mortgage lien, there must be not one penny of equity securing the second mortgage lien.

In the example above, if we assume that the value of the property is $185,000 with all the other factors remaining the constant, there will be $5,000 in equity securing HELOC Bank, thus the Does cannot strip the lien.

Do not hesitate to attempt lien stripping

Consultation with a qualified bankruptcy attorney is essential for those thinking about lien stripping. If the attorney believes that the property is low enough to allow for lien stripping, it makes sense to proceed since creditors do not have incentive to fight the proceeding. After all, if the creditor prevails, and the debtor afford the payments to keep the home, the creditor can’t get paid anyway. In a closed case the call will go to the debtor.

The problem we usually see is when there is sufficient equity in the home to prevent lien stripping while at the same time, the homeowner cannot pay the first mortgage. This is truly cause for a bankruptcy consultation.

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When hiring a law firm or lawyer to represent you in the courts, we suggest that you ask prospective firms whether you will be dealing with a partner or an associate throughout your case. At Mitchell & Culp, you always deal with a partner, never an associate learning the ropes or a lawyer who decided to jump into the growing market for bankruptcy practitioners.

Rick Mitchell

My law partner, Rick Mitchell, was the first Chapter 7 bankruptcy trustee appointed to the Western District of North Carolina bankruptcy trustees’ panel in the 1970s, and has served continuously in that capacity since his appointment. His 30+ years as a bankruptcy trustee, and as an attorney representing creditors, trustees, and debtors in consumer and business bankruptcy cases, gives Mitchell & Culp, PLLC clients a wealth of practical and legal knowledge to draw upon. In addition, the North Carolina State Bar has certified Rick as a specialist in consumer and business bankruptcy.

Heather Culp

I came to bankruptcy law through my work representing clients in construction litigation, a field rife with bankruptcy filings. For the past ten years I’ve concentrated in the areas of business litigation, bankruptcy and bankruptcy litigation, and have many years’ experience in representing businesses, business owners, and individuals in a wide variety of contract and payment disputes.

I also regularly represent court-appointed officials (such as bankruptcy trustees and receivers) in bankruptcy and business court cases. A smaller, but important, part of my practice includes advising clients on the pros and cons of, and procedures for, debt settlement, as well as substitute trustee engagements in commercial foreclosures.

What to expect when filing for Chapter 13 bankruptcy

1. The Chapter 13 process starts with a telephone call to our office, during which we obtain basic information from you, and, if appropriate, schedule an initial consultation with you, in our office.  There is no charge for the consultation unless and until you hire us.  During the consultation, we’ll discuss what you own, what mortgages or liens are on the property that you own, what debts you have, your income, and other facts relating to your finances. We’ll also tell you your legal options and what they will cost, and make some recommendations to you about when you should file, if you choose to do so.
2. When you hire us to represent you in a Chapter 13 bankruptcy, we’ll guide you through the process of completing a mandatory online credit counseling course and preparing your bankruptcy petition and schedules.
3. After our office files your petition, your creditors are forbidden from contacting you about the debts in your bankruptcy — creditors must communicate with us, through an orderly court process.
4. After your case is filed, you will make one monthly payment to the local Chapter 13 bankruptcy trustee, for the number of months provided for in your bankruptcy plan (generally, sixty months or five years).  The payment amount is based on either your disposable income or the value of the non-exempt property that you wish to keep but would otherwise lose to creditors in a Chapter 7 bankruptcy (or as a result of execution on a judgment against you).  Note:  every case is different, but generally, Chapter 13 debtors pay a very small percentage of their unsecured debts, such as credit card debt and medical debt.
5. Approximately four to six weeks after your petition is filed, you must attend a hearing known as the first meeting of creditors; the hearing is not in a courtroom, and there is neither a judge nor a jury.  A representative of the Chapter 13 Trustee’s office will ask you questions about your petition; creditors have the right to attend and ask questions, but rarely do.  We attend this hearing with you.
6. You must also complete a second online course on financial management.  After that, your main job is to make your monthly payments during the duration of your plan.  There are rules limiting Chapter 13 debtors’ ability to incur debt while their Chapter 13 case is open, and some other aspects of the bankruptcy code to understand and work under.
7. Once the Chapter 13 payments are complete, debtors obtain a discharge:  a written order from the bankruptcy court, canceling the discharged debts.  When the discharge order is entered, a permanent injunction is in place, prohibiting creditors from attempting to collect the discharged debts.  This injunction lasts through your lifetime.

Together, we will determine the best strategy for legally handling your financial troubles. Call our office for an initial consultation.

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The problem is that creditors aren’t willing to wait as long as necessary to receive payment in full. This is where Chapter 13 bankruptcy comes in. Those who file for Chapter 13 protection will end up paying all or part of their debts in a court-approved and -monitored process.

Consider the downside of debt settlement

We always disclose to clients that debt settlements often give rise to debt forgiveness income, and that income can be taxable. Credit card settlements almost always give rise to debt forgiveness income; the credit card company will inform the IRS of the amount of the debt forgiven.

Factor in the tax consequences of settling when considering debt settlement. If you cannot pay the taxes you will incur with the settlement, we do not recommend you enter into an agreement.

Credit card companies typically require a lump sum settlement paid in no more than four monthly installments, so debtors hoping to settle need to have a pile of cash at the ready.

Don’t touch retirement savings

We NEVER advise clients to take money from retirement plans to settle their debts.

(1) 401(k)s, IRAs, and other ERISA-qualified retirement plans are exempt (protected from creditors). I

(2) Burning through a 401(k) to pay mortgage payments or other debts creates problems.

• First, early retirement distributions are subject to both ordinary income tax and a 10% penalty, meaning it’s an expensive way to get money.
• Second, income taxes incurred through early retirement distributions are not immediately dischargeable in a bankruptcy, and the IRS can be a very pushy creditor – much harder to deal with than a mortgage or credit card company.
• Third, there may not be any money to live on come retirement time.
• And fourth, in the event that a bankruptcy becomes the best way to deal with debt problems, the early retirement distributions are income that may mess up eligibility for a Chapter 7 bankruptcy.
• And fourth, in the event that a bankruptcy becomes the best way to deal with debt problems, the early retirement distributions are income that may mess up eligibility for a Chapter 7 bankruptcy.

If you are tempted to enter into a debt settlement arrangement or are considering tapping your retirement savings to pay creditors, seek qualified legal counsel first. It starts with a bankruptcy counseling session.

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Dr. Krugman endorses the Oscar-winning film about the 2008 financial crisis, Inside Job,  and says recent efforts by attorneys general to force mortgage companies to modify mortgages that make economic sense to both parties are doomed.

What to do if you can’t get a mortgage modification?

First, we ask you to reconsider filing for a modification in the first place. Some statistics suggest that only 35% of those who have filed have been granted permanent modifications. However, in our experience, that is high; the great majority of our clients do not obtain permanent modifications that are lower than their original mortgage payment. Mortgage companies have found ways to string homeowners along with no intention of granting permanent modifications because the mortgage companies are able to collect servicing fees as long as the property has not been foreclosed upon. You might refer to this as “kicking the can down the road,” but foreclosure is the final outcome in 65% of cases, not modification.

There is a better way to keep your home. One that is governed by law and supervised by the courts. It’s called Chapter 13 bankruptcy.

Many debtors file Chapter 13 bankruptcy cases in order to catch up on their mortgage and try to hold on to the property. During their bankruptcy, Chapter 13 debtors must pay any pre-petition mortgage arrearage if they are to keep their homes.

If you are trying to get a modification and are still working/earning an income, a  Chapter 13 bankruptcy filing may be your most viable solution. Chapter 13 repayment plans last a minimum of three years and a maximum of five years, providing 60 months to make up pre-petition mortgage arrearage.  Remember that at the same time, current monthly mortgage payments must be made.  Chapter 13 bankruptcies also generally require that unsecured creditors — such as credit card companies, medical service providers, etc. – be paid a fraction of what they are owed.

Any type of bankruptcy filing requires the skills of an experienced attorney.  Be prudent in selecting your financial advisors, including attorneys.

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Chapter 13 may give you hope against a hopeless modification process

I saw an interesting article about a Pennsylvania judge who forces the mortgage companies trying to foreclose on homes in his jurisdiction to first try and work out a modification with the homeowner. Mortgage companies cannot proceed until they have proven a good faith effort to the court.

Even that’s not enough to help most people save their homes. 20% of borrowers  (or more) with permanent modifications are likely to re-default, primarily because of high overall debt levels.

Chapter 13 bankruptcy is a comprehensive financial workout strategy

A modification is not without its downside, as we’ve reported elsewhere. If you are trying to get a modification and are still working/earning an income, a  Chapter 13 bankruptcy filing may be a better way to remedy your situation.

Chapter 13 repayment plans last a minimum of three years and a maximum of five years, and, generally require that unsecured creditors — such as credit card companies, medical service providers, etc. – be paid a fraction of what they are owed.

One monthly payment

Chapter 13 debtors send one monthly bankruptcy payment to the bankruptcy trustee’s office; the trustee uses those payments to repay debts that are included in the bankruptcy.  New local rules require that Chapter 13 debtors also send their current monthly mortgage payments to the trustee, who distributes them to the mortgage company.  This helps avoid any confusion as to whether payments to mortgage companies are in repayment of arrearages that accrued prior to the bankruptcy, or are for current obligations.

It begins with a bankruptcy counseling session

If you’re considering a mortgage modification or considering just walking away from a house you can no longer afford, get the full legal picture through a no-obligation bankruptcy counseling session. At the end, you’ll have:

• Asset planning and protection strategies
• An analysis of whether you are at risk of re-defaulting after a mortgage modification
• A referral to agencies that may be able to help you with your financial difficulties

You say you want to avoid bankruptcy at all costs?  A bankruptcy counseling session will give you the facts you need to do so.

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Chapter 13 bankruptcy must be considered for HAMP upon request

According to the American Bankruptcy Institute, “These guidelines, originally proposed in March, greatly increase the attractiveness of chapter 13 as a platform to obtain a mortgage modification under HAMP. Under the new provisions, homeowners in chapter 13 are required to be considered for HAMP upon request. The chapter 13 plan may provide for modified payments at 31 percent of gross income, thus allowing chapter 13 debtors a means to reduce their mortgage to an affordable level.”

We’ve written at great length about mortgage modifications.  Mortgage companies and other creditors have legal counsel and you should also.

If you are experiencing financial difficulty, consult a qualified legal professional before taking any action.

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For most individuals with debt problems, the major decision is whether to file for protection under Chapter 7 or Chapter 13 of the Bankruptcy Code.

Chapter 7 does not require repayment of unsecured debt; the debts are simply wiped away.  However, Chapter 7 is not available to all debtors.

Chapter 13 for individuals

Chapter 13 is an option for individuals who either have too much disposable income to qualify for a Chapter 7 bankruptcy, or who wish to retain real or personal property with equity that creditors could otherwise reach. We can advise you as to which type of bankruptcy case is the best fit for you.

Chapter 13 repayment plans last a minimum of three years and a maximum of five years, and, generally require that unsecured creditors — such as credit card companies, medical service providers, etc. – be paid a fraction of what they are owed.

IMPORTANT: mortgage payments missed before the filing of a Chapter 13 bankruptcy can be repaid during the Chapter 13 bankruptcy, allowing homeowners to stay in their houses as long as they keep current on their monthly payments as they are due during the bankruptcy.

Chapter 13 debtors send one monthly bankruptcy payment to the bankruptcy trustee’s office; the trustee uses those payments to repay debts that are included in the bankruptcy.  New local rules require that Chapter 13 debtors also send their current monthly mortgage payments to the trustee, who distributes them to the mortgage company.  This helps avoid any confusion as to whether payments to mortgage companies are in repayment of arrearages that accrued prior to the bankruptcy, or are for current obligations.

“This information is general and thus incomplete, and the reader should seek legal counsel for specific legal problems or questions.”

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