If you’re under water on a second mortgage, you may be in luck. Chapter 13 Bankruptcy provides two options for solving this issue. Those two options are referred to as lien strip and cramdown. Both options can be advantageous to the property owner who has real estate valued at less than the amount owed on a first mortgage. These options are provided for under the law to promote property ownership while protecting individuals from overwhelming debt. Depending on your situation, one option may be more beneficial than the other. Ultimately, the question comes down to whether or not the property is your homestead.
Quick Review of Chapter 13 Bankruptcy
Commonly, we refer to Chapter 13 as a government sponsored debt consolidation plan. Unlike traditional consolidation plans, Chapter 13 bankruptcy provides relief to debtors in many different ways. Through a Chapter 13, debtors can propose a repayment plan to the court whereby debts are satisfied through monthly payments over three to five years. Your monthly payment plan is primarily based on disposable income. There are certain caveats to this, however, and one of our MN Bankruptcy Attorneys can help you navigate the specifics. There are certain expenses that must be paid, in-full, through the Chapter 13 depending on what your case requires. With that said, Chapter 13 provides similar relief to that of a Chapter 7. Once your Chapter 13 is complete, any amount of money still owed to unsecured creditors is forgiven, tax free, forever. Below are two additional examples of ways a Chapter 13 bankruptcy is beneficial to those struggling with overwhelming debt tied to real property.
Lien Strip in a Chapter 13
A lien strip allows debtors whose homestead is worth less than their first mortgage to strip subsequent mortgages. The operative word here is “homestead”. Lien stripping is most successful when we do this for property you homestead. Most creditors object to lien stripping when a debtor attempts to strip the second mortgage on non-homestead property. We often come across this when it has to do with second homes or rental properties.
Let’s illustrate this by example. Say a debtor’s homestead is worth $80,000. Your first mortgage is $100,000 and second mortgage is $25,000. In this scenario, lien stripping would be beneficial to the debtor because we can eliminate the secured interest on the second mortgage. Through a Chapter 13 bankruptcy, the second mortgage is treated as an unsecured debt. During the five-year repayment plan in a Chapter 13, the second mortgage gets paid back just like credit card debt. Most often, the second mortgage company will only receive pennies on the dollar. At the end of the five-year repayment, any amount still owed on the second mortgage is eliminated, forever.
Because of the possibility of stripping the lien on a second mortgage, creditors try as hard as they can to prevent you from doing this. So, it’s important to know the exact numbers we’re working with when we file your case. It’s important to have a recent appraisal and to know the exact amounts owed on the mortgages.
Cramdown in a Chapter 13
Cramdown operates differently than a lien strip in a few different ways. Ultimately, we’re able to eliminate your liability on second mortgages if your property value is less than what is owed on the mortgages, however we go about doing this in a different fashion. When you cramdown your mortgage in a Chapter 13, you are proposing to the court the amount paid on your property should not exceed current market value. For example, if your house is worth $80k, but the first mortgage is $100k, we would propose cramming down your mortgage so you only pay the $80k your house is worth.
This sounds great, right? Even better, we can cramdown your mortgage (plus interest) on most property you own. This can be done on non-homestead property. So, if you have rental properties, this may be an option for you. Unlike in a lien strip, we can cramdown your mortgage so you only pay what the house is worth.
In order to do this, we propose a monthly payment plan to the bankruptcy court. The issue with cramdown, however, is the new balance you propose to pay back will have to be paid back, in-full, during the three to five-year Chapter 13 plan. This can lead to having a very expensive monthly payment. Unfortunately, the court does not allow us to tack a balloon payment on the end of the Chapter 13 plan, commonly due to lack of feasibility. Unless we can prove to the court a justifiable reason to include a balloon payment, we won’t be successful in proposing it. So, the full amount of the mortgage, after cramdown, would have to be paid in the Chapter 13.
An additional benefit to using the cramdown method in a Chapter 13 is the ability to adjust the interest rate and payment duration on your property. Generally speaking, we can reduce the interest rate owed to approximately 5.25%. This can be a great option if your current interest rate is anything over 5.25%. Also, we can stretch your payment duration to be for the entire five-year Chapter 13 repayment. Sometimes it is not beneficial to do this, but one of our experience bankruptcy attorneys can discuss these options with you.
Unlike traditional debt consolidation, Chapter 13 bankruptcy provides individuals with relief from their creditors in a number of ways. Interest free repayment on debts an individual can afford to pay back is the most notable benefit. Further, if an individual is struggling with overwhelming mortgage payments, Chapter 13 may be able to eliminate liability on most, if not all, of the amount owed. The topic of lien stripping and cramdown is convoluted and requires the experience of a qualified bankruptcy attorney to navigate the various options.
If you think Chapter 13 bankruptcy is a good option for you, or if you want to find out more about how bankruptcy works, please contact one of our MN Bankruptcy Attorneys. We’re happy to help in any way.