– Debt Relief with a Chapter 13 Bankruptcy –

Most people who file for bankruptcy will file under Chapter 7. However, there are some people for whom chapter 13 would be the preferred course, and there are other people for whom chapter 7 is simply unavailable. Most chapter 13 filers come in one of these categories:

Debtors Whose Income is Above Median and are Subject to the Means Test 

A high income debtor is a person whose family income is above the median for a family the debtor’s size in the debtor’s state. Median income is published by the Census Bureau and this is the link to that data. The means test is a budget formula which determines if debtors can make any contribution at all to their debts. No link to the means test is included, as to many high income debtors simply do it wrong when they try to do it on their own. If the means test says that you can pay something toward your debts, even if you can not pay all of them, then Chapter 7 is not the right chapter and you must file under Chapter 13.

Debtors Who Filed a Chapter 7 in the Past 8 Years 

You cannot receive a second Chapter 7 discharge for a petition filed within 8 years of the previous Chapter 7 filing. However, the wait to file under Chapter 13 and receive a discharge after a Chapter 7 filing is only 4 years. Although it does not happen very often, there are some people who need to avail themselves of this shortened waiting period.  These waiting periods only apply if the previous filing resulted in a discharge.

People in Arrears on Their Mortgages

Before the bankruptcy reform which created the means test and lengthened the waiting period to 8 years, most chapter 13 filings involved people who had fallen behind on their mortgage payments. In chapter 13, it is possible to prevent the bank from foreclosing on your home or other property by reorganizing the mortgage arrears over a 3 to 5 year period. As long as all payments are being made, the bank cannot foreclose. Once all the plan payments are complete, you can simply go forward with your life and keep the property as if you never fell behind in the first place.

In addition, chapter 13 may also be used to reorganize arrears on car loans, loans on investment property or any other secured loan

People Who Wish to Strip off Junior Mortgages 

If you find yourself in a situation where you have a second mortgage or home equity line or any form of junior mortgage which is entirely unsecured by the underlying property, it can be stripped off in chapter 13. That is to say, it will be treated like an unsecured debt and removed as an encumbrance on the property. As result of the recent collapse in real estate prices, many second mortgages are now unsecured can be stripped off in Chapter 13.  Unfortunately, the bankruptcy code does not permit mortgage stripping in Chapter 7.  However, Judicial liens may be stripped off in both Chapter 7 and Chapter 13.

People Who Need to Protect Assets with Large Amounts of Equity 

Before the real estate market collapsed, and back when Massachusetts only had a $100,000 homestead exemption, chapter 13 was very popular with people who were otherwise eligible for Chapter 7, except that they had too much equity in their homes. A chapter 13 allowed these people essentially to buy out the equity in their homes and avoid losing them. Now the Massachusetts homestead exemption is $500,000, although the New Hampshire exemption remains at $100,000.00 for single person. That, coupled with the reduction in the value of real estate, has meant that very few people find themselves in a position of being asset rich but cash poor. However, there may still be people who own things that they do not wish to part with, but cannot exempt.

Cram Down Undersecured Mortgages

For any secured debt other than a single-family residence, it may e possible to “cram down” the principal balance of a first mortgage or other secured debt to the value of the property.  For example, if you live in a multifamily house that is worth $200,000 but you owe $300,000 on it, it may be possible to reduce the principal balance of your mortgage to $200,000.  Unfortunately, there is some ambiguity now in Massachusetts concerning how the cram down is done, and it may depend upon the luck of the draw in terms of which Judge hears your case.  Nevertheless, we have successfully crammed down mortgages on investment properties.

Chapter 13 may allow for some creative ways of avoiding foreclosure. We have seen situations where people were turned down for mortgage modification then filed Chapter 13 and received a mortgage modification. We have seen situations where people facing foreclosure filed Chapter 13 and refinanced, although we have not seen this since the financial crisis started. We have seen situations where people were at risk of losing their home to foreclosure, filed Chapter 13 and then arranged the sale of the property to a third party or even to a family member.  We have seen cases where people were uncertain as to what they wanted to do with the house, but knew that they did not want to be foreclosed right then and there.  They filed Chapter 13 and paid the plan for a period of time while they figured out what their situation was going to be. In some cases, people’s situation stabilized and they ultimately decided to stick with the plan and keep the house. In other cases, they continued to struggle or things got even worse, and they converted to chapter 7.

Once a decision is made to file Chapter 13, the next question becomes how much should the monthly plan payment be and for how long should payments be made. For people subject to the means test, the answer is quite simple. The payments shall be what the means test says they should be, and the length of the plan will be 5 years. The only exception is when the means test numbers pay more than 100% of the unsecured debt. Then the plan can be adjusted to reflect the fact that there is no reason to be paying more than 100% of the debt.

For everyone else, it is more complicated. The length of the plan can not be longer than 5 years or less than 3. The plan payments need to be enough to pay off any mortgage arrears or protect any assets, if that was the purpose of filing chapter 13. Commonly, the mortgage reorganization plans and the protect asset plans are five-year plans. If a Chapter 13 was filed to strip off a mortgage or because a Chapter 7 discharge was received in the last 8 years, then the plan is likely to be a 3 year plan in whatever amount of money the debtor’s budget says the debtor can support. Typically these are very small plans. Usually in these situations we are stretching the budget to try to get to the point that the debtor can pay $100 a month for 3 years and prevent opposition from the Chapter 13 Trustee.

Chapter 7 is usually better for your credit. There are many people, including many people who purport to be bankruptcy lawyers, who will say that making some payment in Chapter 13 is better than making no payment through Chapter 7. These people are wrong! Chapter 7 discharge would already be about 3 years old by the time you receive a chapter 13 discharge. Assuming that everything else in your life is going well, If you are working steady, paying your bills on time, and have not had any other financial issues arise, then you are already well into the process of rebuilding credit. In fact, you may even be at the point where you can get a good mortgage rate. For most people with steady employment, credit cards and car loans should already be available. As a result, chapter 13 is not the better way to go if your goal is to rebuild credit quickly. There may be an exception to this statement for people who were trying to avoid foreclosure. Typically, Chapter 13 prevents a home from being foreclosed upon. Chapter 13 thus prevents a pretty serious hit to the credit score that comes from the act of foreclosure itself. In some cases that might make Chapter 13 superior to chapter 7 in terms of rebuilding credit.

Chapter 13 is superior to Chapter 7 on the relatively few occasions referenced above. If Chapter 7 is unavailable; if Chapter 13 is the only way to save your home, or if Chapter 13 will enable you to protect assets or strip off or cram down mortgages, then Chapter 13 is often the better way to go. In every other scenario chapter 7 is usually better.