Bankruptcy by Example: Stop a Foreclosure and Keep Your Home through Chapter 13

File a Chapter 13 case to stop a home foreclosure and then keep it permanently, or be able to sell it in a few years.

What Are the Tools in the Chapter 13 Tool Chest?

Chapter 13 “adjustment of debts” gives you so many tools by which to help you keep your home permanently. It can:

1. give you up to five years to catch up on any back mortgage payments—much longer than mortgage lenders would allow after a Chapter 7 case—making the possibility of catching up more realistic.
2. enable you to “strip” your second (or third) mortgage from your home’s title, usually saving hundreds of dollars per month and tens of thousands (or more) of dollars with the completion of your case, and then for years to come if you keep your home for a long time (with the saving in both principal and a potentially huge amount of interest); this is completely unavailable under Chapter 7.
3. enable you resolve other liens on your home—for property taxes, income tax, and child support—usually in a very beneficial way.
4. protect any equity in your home that you may have beyond the applicable homestead exemption, which would be at greater risk under Chapter 7.
5. reduce or even eliminate what you pay to most or all of your other creditors, so that you can focus your financial resources on paying for your home
6. allow you to prioritize and pay for other very important debts—vehicle loan(s), recent income taxes, regular child and spousal support and any arrearage—at the same time as, or sometimes even ahead of, your home arrearage payment.
7. eliminate judgment liens, removing them from your home’s title,  and then discharging (writing off) the debts that caused those liens; also available under Chapter 7 but not with the package of other tools Chapter 13 provides.
8. allow a great amount of flexibility in timing for the selling or surrendering of your home, whether planned for at the beginning of the case or as a result of changed circumstances.
9. protect your home from foreclosure by your mortgage lenders(s) throughout the three-to-five-year period.
10. prevent new liens from attaching to your home throughout this same period, such as for previously unpaid income tax or child support.

Our Example

The following example illustrates just the first three tools in the above list, to avoid getting too complicated.

Scott owns a home that was worth $290,000 in 2007, but is now worth $245,000, with home values climbing slowly but steadily in his neighborhood in the last couple years. He owes $264,000 on his first mortgage, and $26,000 on his second mortgage, is significantly behind on both, and just missed paying his annual property tax of $2,100.

Long-divorced, he shares custody for his 16 year old daughter, who thinks she wants to join the Air Force as soon as she turns 18. At that point Scott would like to move out of state to where he grew up, to be closer to his elderly parents, and where job opportunities are better. But he’s not sure if his daughter might change her mind, so he may want to keep his home after all if he can. He currently has steady work, but the last three-four years has been really rough financially. He owes:

• $30,000 in credit cards
• $15,000 for medical bills incurred while he was unemployed and uninsured
• $3,000 in federal income taxes from 2008 when he did not have enough withheld from his wages. He did not file that year’s tax return until last year, and the IRS just recorded a tax lien on it against his home.
• $2,100 in back property taxes on his home
• $9,000 in arrearage on his 1^st mortgage
• $2,800 in arrearage on his 2^nd mortgage

Using the Tools of Chapter 13

Scott meets with a bankruptcy attorney and tells him about his intention to move in two years, but that he needs to keep his options open. After reviewing all the advantages and disadvantages, his attorney advises him to file a Chapter 13 case, to which Scott agrees.  This is what it accomplishes:

1. Scott gets five years to catch up on the $9,000 in first mortgage arrearage, so though his Chapter 13 plan he pays about $150 per month towards that over 5 years. If he had instead filed a regular Chapter 7 case, his mortgage lender would have likely required him to catch up within a year, amounting to payments of about $750 a month, which Scott simply did not have the ability to pay.
2. His attorney files a motion to “strip” the $26,000 second mortgage off his home, which can be done because the home is worth less than his first mortgage balance. The motion is successful. In addition to saving Scott the monthly payment of $260 dollars per month, he avoids paying the $2,800 in back payments. And importantly, “stripping” this $26,000 debt brings his debt on the home much closer to its value, and so puts him much closer to actually building equity in his home again. If Scott keeps the home for a while, the interest on that $26,000 that he avoids paying would itself amount to a huge savings to him over time. (Over the full life of just about every conventional mortgage, the amount of total interest is by far large that the amount of the principal being repaid.)
3. Scott has to pay the $2,100 back property tax within his Chapter 13 plan, but he would have had to even if he had filed a Chapter 7 case. It is a very high priority lien on his home, one that even comes ahead of his first mortgage. If he wants to keep his home he has to take care of it. Chapter 13 provides a way to pay that while preventing the country or other local taxing entity from foreclosing on his home because of that unpaid property tax.
4. He has to pay the $3,000 in income taxes. That has to be paid in full because Scott filed the returns less than two years ago. But he doesn’t have to pay any additional interest or penalties because the income tax lien is effectively unsecured—there is no equity in the home beyond the first mortgage.  The income tax is also paid through Scott’s Chapter 13 plan, essentially whenever works best for Scott in light of his other important debts, as long as it is paid within the five years.
5. The $45,000 of his other debts—$30,000  in credit cards and $15,000 in medical bills—plus his second mortgage balance of $36,000, totaling $81,000, only have to be paid to the extent Scott can afford to do so after paying his higher priority debts. They do not have to be paid anything if those other obligations stated above—plus trustee and attorney fees—exhaust all of Scott’s disposable income during the plan’s five years.
6. In two years when his daughter turns 18, Scott can keep the Chapter 13 plan going as originally proposed and approved, and continue living in the home. If so, when he finishes his case, he will have caught up on his first mortgage, paid off his back property and income taxes, and would owe no other debts.
7. Or in the alternative, if two years from now he wants to sell his home and move, he likely would be allowed to do so. At that point his plan could be amended to account for his changed circumstances. Or instead, depending on his circumstances at that point, he could convert his case into a Chapter 7 one, discharge his debts and be debt-free that much faster.