Refresher: Benefits of Chapter 13 – why it can be so great.
Saving Your Home
One of the main benefits of Chapter 13 is saving your home. If you are behind on mortgage payments, especially enough so that you are being threatened with foreclosure, catching up in time to save your house may be impossible. If you file a Chapter 7 case, usually you’ll get at most a year or so to catch up – sometimes only 90 days. If you are thousands of dollars behind, that’s not enough time.
BUT, under Chapter 13…
Dick and Jane fell 10 payments behind on their $1,550 mortgage while Jane was unemployed. With her new job, they can now afford their monthly mortgage payment. But if they discharged their other debts (legally wrote off) in a Chapter 7 case –credit cards racked up to make ends meet during Jane’s unemployment and medical debts that piled up while she wasn’t insured—they would only free up about $350 per month to pay towards the $15,500 mortgage arrearage. Over the course of a full year, that would only make a small dent in the arrearage, and their mortgage lender is about to foreclose.
They can save their home under Chapter 13 because Dick and Jane would be able to stretch out the time for curing the mortgage arrearage for as long as 5 years, and the mortgage lender has no choice but to agree to that and stop the foreclosure. If they put that $350 per month into their Chapter 13 plan, it would be enough to get caught up and save their home in 5 years or less. At the end of their Chapter 13 case, they would owe nothing on the credit card and medical debts and they would be current on their mortgage.
The “Cramdown” – Keep a Vehicle That You Could Otherwise Not Afford
When you are underwater on your vehicle loan, one of the benefits of Chapter 13 is being able ot keep your vehicle and only pay in full the equivalent to what it’s worth (as well as usually getting a decreased interest rate – [rime plus 2%). Under Chapter 7, if you need to keep a vehicle on which you’re making payments, most of the time you have no choice but to “reaffirm the debt”—legally commit to paying the full debt with your original contract terms, including the full monthly payments, as if the bankruptcy never happened.
BUT, under Chapter 13…
Jack has had a vehicle loan more than 2 and a half years. It has a $20,000 balance, with monthly payments of $550. The vehicle is only worth $12,000 now. If he filed a Chapter 7 case, in all likelihood he would have to “reaffirm” the $20,000/$550 per month vehicle loan—that is, make a legally binding agreement to exclude that vehicle loan from the Chapter 7 discharge of debts, OR surrender the vehicle to get out from under that loan. However, under Chapter 13 “cramdown” Jack would only have to pay in full the secured portion of the vehicle loan – the value of the vehicle – $12,000, and likely at a lower interest rate (right now it’s about 5.25%). He would not need to pay the remaining unsecured portion of the loan-$8,000—except to the extent he had extra “disposable income” during his Chapter 13 plan to do so.
So through “cramdown” Jack can reduce his vehicle monthly payments from $550 to about $275 over a term of about 4 years. At the end of that time he would own the vehicle free and clear, having saved at least $10,000 in payments and interest.
Second Mortgage Lien Stripping
Usually, real estate mortgages survive bankruptcy. If you have a first mortgage with a debt larger than home’s value, and owe a second mortgage as well, a Chapter 7 bankruptcy filing would not affect either the first or second mortgage liens. If you wanted to keep the home, you’d have to pay both mortgages.
BUT, under Chapter 13…
Julia owns a home that used to be worth $350,000 just before the real estate crash of 2008-09. The home’s value hit bottom at $250,000 about three years ago and has been climbing slowly so that it is now worth $280,000. She owes her first mortgage lender $295,000, with a monthly payment of $1,275, and her second mortgage lender another $35,000, with a monthly payment of $300.
Because Julia’s first mortgage debt is larger than the value of the home, leaving no equity to secure the second mortgage, that second mortgage lien on the home’s title can be “stripped” off the title. This converts that debt into a “general unsecured” one, so that she would no longer need to make the $300 monthly payments. The balance on that second mortgage debt would only have to be paid as much as Julia could afford to do so during the Chapter 13 case, and then the rest is wiped out – maybe just pennies on the dollar. At the end of her case Julia’s home would only be encumbered by the first mortgage.