In the previous installment of our “Basics of Bankruptcy” series, we discussed some of the reasons to file a Chapter 13 bankruptcy vs. Chapter 7 based on income and assets.
This post looks at reasons, specifically in relationship to mortgages, why Chapter 13 might be the better personal bankruptcy choice for you (the debtor) than Chapter 7.
Curing a mortgage
Summary: Since a debt secured by the debtor’s home (principal residence) cannot be modified, Chapter 13 can give the debtor time to catch up on (cure) mortgage payments, as it provides the debtor three to five years to accomplish the “cure.”
Mortgage creditors are afforded special protection in Chapter 13; a debt secured by a principal residence of the debtor cannot be modified through the filing of a bankruptcy. See 11 U.S.C. §1322(b)(5)1 and Nobleman v. American Savings Bank, 113 S. Ct. 2106 (1993)2, holding that home mortgages secured only by the debtor’s personal residences cannot be modified to discharge any unsecured portion of the claim. With the few exceptions discussed below, a Chapter 13 is useful for curing mortgage arrears, as it provides the debtor three to five years to accomplish the cure.
In Indiana, a sheriffs’ sale is not final until the gavel falls, and many Chapter 13’s are filed on the eve of the sale to save the family home. When curing a mortgage in a plan, the cure runs through the month that the petition is filed and the current mortgage payments begin the following month. When setting up a mortgage cure in a plan, it is important to estimate the amount of the arrears as closely as you can. Beginning on August 1, 2009, the Chapter 13 trustees have become “residential mortgage conduit trusteeships” meaning that all delinquent residential mortgages will be paid through the Chapter 13 trustee (plus statutory fees).
Cramming a mortgage – cross-collateralization
Summary: “Cram” is a word of art in bankruptcy practice. It literally means reducing a secured debt to the fair market value of the subject collateral. It is most often used with regard to automobiles, but it may also be used for household goods or even mobile homes. When cramming in a plan, the debtor offers the fair market value of the collateral with interest; the balance of the debt is treated as an unsecured claim.
In some limited instances, case law has provided circumstances in which a residential mortgage can be crammed. Mortgage cramming is the popular term for court-ordered loan adjustments on investment properties, in which a court order “crams” down the principal of the mortgage to the fair market value of the property. Mortgage cramming is only available as an option in certain situations, and can’t be used by homeowners though courts can order other adjustments to home mortgages if needed.
First, if the mortgage is cross-collateralized with any other collateral, it loses the protection afforded under the Code. §1322(b)(2) provides that secured claim holders may be modified “other than a claim secured only by a security interest in real property that is the debtor’s principal residence” (emphasis added).
Case law has interpreted that to mean if the real estate is income-producing (rental income), if the mortgage includes the residence and commercial property, or if the mortgage includes the residence and equipment, other acreage or anything other than the personal residence, the mortgage can be “crammed” to the fair market value.
- If you have a mortgage that you wish to cram, valuation becomes the primary issue, and value agreements become more difficult to orchestrate.
- If you are attempting a mortgage cram, it would be in your best interests to have a recent appraisal of the property available to the creditor to substantiate your offer.
- Also, remember that you need to deduct the value of the other pledged collateral, and the other pledged collateral must also be provided for in the plan – either with a payment offer or to surrender.
“Stripping” a wholly unsecured junior mortgage
Summary: Some court decisions have allowed the debtor to strip off a junior mortgage if there is absolutely no equity to support the note.
Additionally, there have been some decisions that allow the debtor to strip off a junior mortgage if there is absolutely no equity to support the note. See Matter of Sanders, 202 B.R. 986 (Bankr. D. Neb. 1996), holding that the “creditor must have a secured claim in both the literal and Code sense to have its rights protected by the anti-modification clause,” and In re Geyer, 203 B.R. 726 (Bankr. S.D. Cal. 1996)4, “where the estate’s interest in property is zero, the claim under §506(a)1 is completely unsecured and thus not entitled to §1322(b)(2) protection.” In determining the amount of equity available to support a mortgage, you may not deduct any exemptions to which the debtor may be entitled. Again, an appraisal is vital in attempting this type of cram as the lien holder may object to this severe treatment.
Our next installment of this series will take a look at how cars and other personal collateral can be protected in a Chapter 13 bankruptcy.
(links open in new windows)
1. Cornell University Law School Legal Information Institute
2. United States Bankruptcy Court, Northern District of Ohio
3. United States Bankruptcy Court for District of Nebraska
4. United States Bankruptcy Court, Southern District of California