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Using Bankruptcy to Save Your Home |
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General Rule. A Chapter 7 bankruptcy can help save a family home in limited circumstances. Generally the elimination of other debt such as credit card bills and car loans is the biggest benefit to a Chapter 7. Chapter 13 is used more often to save a home because it allows you to pay any mortgage arrears (delinquency) over a 3 to 5 year period and it reduces the payments you must make to unsecured creditors, such as credit cards. At the end of the Chapter 13 plan, your unsecured debts are discharged (eliminated.) |
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Federal law allows individuals to obtain a fresh start and get back to being a productive citizen by using a bankruptcy filing to start over. This is similar to the IRS laws which provide for the reduction of tax debts so that people can become productive taxpayers again.
Most homeowners can use bankruptcy to obtain temporary or permanent relief from foreclosure and/or execution of a court judgment or tax lien. They also get the relief from other bills by eliminating many unsecured debts such as credit cards, car loans, medical debts, etc. Although sometimes a Chapter 7 filing can help you, most often homes are saved with a Chapter 13 filing.
Most Chapter 13 reorganization filings are for the purpose of defending a home from foreclosure and eliminating other debts. The purpose of a Chapter 13 plan of reorganization is to allow the honest debtor breathing room to address their financial situation and to finish the plan current and up-to-date on their mortgage.
The Automatic Bankruptcy Stay
The filing of a bankruptcy automatically prevents essentially all creditor actions against the debtor and the debtor’s property, including foreclosure and even all collection calls.
Chapter 7 Liquidation of Debts
Some people can get relief by filing a Chapter 7 bankruptcy. Because Chapter 7 instantly eliminates credit card debt and other unsecured debt. Car loans can be eliminated if your turn the car back to the lender. Some car loans can be reduced to the value of the car.
In a chapter 7, the filing freezes the debtor’s assets as of the date of the filing and protects exempt assets from the reach of creditors. A chapter 7 could protect a home if the amount of equity in the home is less than the homestead exemption and the owner can pay the mortgage arrears. The trustee cannot sell the home is the amount of equity is less than the homestead exemption. Some of the help in a chapter 7 comes from the relief from other debts, such as credit card and car debts. In most cases, the debtor keeps most or all of their property in a Chapter 7. However, in many cases, chapter 7 does not help with the eventual prevention of the foreclosure, but it can delay it and it will prevent any deficiency judgment if the trustee sells it. In some cases, a Chapter 7 will also allow the owner to keep the value of the homestead exemption (generally now $60,000) if the trustee sells the home. A chapter 7 should not be filed if the only objective is to delay a foreclosure.
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Example for Chapter 7: Here, the Trustee cannot sell the home since the homestead exemption of $60,000 fully protects the $50,000 equity in the home. However, the homeowner will have to pay the $11,000 mortgage arrears after the Chapter 7 ends (or sometimes before it ends) to prevent the foreclosure. The lender might go along with a payment arrangement. However, there is no payment plan for the payment of the arrears similar to that in a Chapter 13 plan. Thus, in a Chapter 7 if the arrears cannot be cured, then the foreclosure may be completed after the Chapter 7 is completed (or earlier if the stay is lifted during the Chapter 7. |
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Income Taxes in a Chapter 7:
Usually your tax debts can also be eliminated if ALL of the following are true:
1. The taxes are income taxes;
2. There is no fraud or evasion;
3. The tax debt relates to unpaid taxes that are more than 3 years past due;
4. You actually filed the tax return at least 2 years before filing for bankruptcy; and
5. The income tax debt was assessed at least 240 days before you file or it has not yet been assessed.
After the Chapter 7 discharge, all of the discharged debts are eliminated and you have your fresh start. If you cannot meet these requirements, you may be able to use an Offer in Compromise.
Except that if you inherit money, get a life insurance policy beneficiary payout, or get money pursuant to a divorce within 180 days of the Chapter 7 discharge, you must inform the court and some of the money will likely be used to further pay your debts.
In order to file a Chapter 7, you must have an income below the median income in Colorado or if not, then you must “pass” the means test to show that you have less than $100 of monthly disposable income which can be paid to unsecured creditors.
The median income in Colorado as of July 15, 2007 based on the number of people in the household is:
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Therefore, after the 2005 change in the law, some people have a high income such that they are forced to file a Chapter 13 instead of a Chapter 7 if they have an above-median income and they cannot “pass” the means test.
Curing a Mortgage Default in Chapter 13
A Chapter 13 filing helps many homeowners where a chapter 7 cannot help them.
In a chapter 13 filing, the automatic stay stops the foreclosure, prevents any collection activity including collections calls, can discharge a lot of unsecured debt, allows the opportunity to get a court-approved debt adjustment and payment plan, and if the plan is successful, gives the homeowner a fresh start.
A big advantage of Chapter 13 over Chapter 7 is that your mortgage arrears (delinquent payments) can be paid over 3 to 5 years in a Chapter 13. It also allows you to pay other bills based on your ability to pay. During a Chapter 13 plan, bill collectors cannot even contact you.
In order to file a Chapter 13:
1. you need a steady income and some level of disposable income;
2. Your unsecured debts (credit cards, etc.) cannot exceed $336,900;
3. Your secured debts (home mortgage, car loan) cannot exceed $1,010,650; and
4. You must file as an individual (or jointly as a married couple), not a business.
Voiding Mortgage Liens in a Chapter 13
In some cases, home mortgage liens (deed of trust) can be voided or stripped-down (a reduction in the amount of the lien) when the loan liens exceed the value of the home. In such a case, the foreclosure can be stopped because the lien being foreclosed is void or of a much smaller amount.
The cases where a mortgage lien can be stripped-down include:
1. Where the real estate is not the principal residence (such as a rental property or vacation
home);
2. The lien is on the residence, but the lien is also secured by additional collateral as well, such as a rental home or a vehicle (credit unions and banks do this a lot);
3. The lien is on the principal residence, but the lien is totally unsecured because the value of the residence is less than the senior liens; and
4. The lien has already been reduced to judgment or will come due during the course of a chapter 13 plan.
Voiding Judgment Liens in a Chapter 13
When a creditor sues a homeowner and gets a court judgment, if unpaid, the judgment will be recorded in the county clerk records. That judgment then becomes a lien on the home. In some cases, the judgment lien may be foreclosed, if there is enough equity in the property. Otherwise, the judgment lien must be paid when the home is sold or refinanced.
Chapter 13 can be used to void the lien to the extent it impairs the owner’s exemption and discharge the underlying debt as an unsecured debt, similar to a credit card debt.
Preserving Equity by Liquidating Property in Bankruptcy
A chapter 13 (and sometimes a chapter 7) can sometimes give the homeowner time to sell the property. A property sale will almost always bring a higher price than a foreclosure sale where the sale is held by bid and usually the lender gets the property. You will have a much greater chance to keep some of your equity by selling your home, paying off the liens, and keeping the balance (at least up to the amount of your exemption - which is $60,000 in most cases in Colorado.)
Reducing or Eliminating Other Debt, such as Credit Cards and Car Loans
A chapter 13 can free up a lot of your present monthly budget so that you have more of your income to pay on the home mortgage.
In general, you will be obligated to pay the amount of your future disposable income over a 3 year to 5 year time period to pay both secured and unsecured creditors. The unsecured creditors get whatever is left over after secured creditors are paid. So, in some cases, credit card companies and other unsecured creditors may receive only pennies on the dollar during a chapter 13 plan.
Car loans can also be stripped off in some circumstances. Generally if the car loan is older than 910 days or any car loan where the car is used primarily for business purposes.
As long as the debtor keeps the chapter 13 plan current, upon the completion at the end of 36 to 60 months, the remaining balance on the unsecured debt is discharged (no longer has to be paid) and the homeowner gets a fresh start.
If you do file bankruptcy, it is usually a private matter. Your employer will not know unless your wages are garnished (before bankruptcy), your relatives and friends will not know.
If an employer fires you or refuses to hire you because you filed for bankruptcy, that employer is unlawfully discriminating against you. A future employer can see that you have taken bankruptcy only if your credit report is reviewed. And it cannot review your credit report unless you first give permission.
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An example of a Chapter 13 plan: Here, in a Chapter 13 plan, the homeowner has a reduced monthly payment of about $1,648.00 per month. And the home is safe. This includes the payment to “catch up” on the mortgage arrears. In this case, we have turned the car back to the lender or lessor. |
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