The rest of the story on how Chapter 13 dramatically and beautifully enables you to keep your home.
In my last two blog posts, I introduced you to Amy and her seemingly impossible hope for hanging on to her home. (Please check out these last 2 posts, or you can just keep reading here and go back to them later.)
First I showed why in Amy’s situation filing a Chapter 7 “straight bankruptcy” would write off tons of her debts but would still not save her home. Second, in contrast, I started explaining how, with only $150 to spare each month to pay ALL her creditors, she can save her home through the tools of Chapter 13.
I’ve got to remind you again about Amy’s debts:
- credit cards: $20,000
- 1st mortgage: $265,000, with arrearage of $6,000
- 2nd mortgage: $45,000, with arrearage of $2,500
- Home property tax arrearage: $2,250
- medical debt judgment lien against her home: $5,000
- 2010 income tax to IRS with tax lien on her home: $2,500
- 2011, 2012, and 2013 income tax to IRS: $6,000
Chapter 13 Solution
Through Chapter 13 Amy either legally writes off (“discharges”), or gets current on, or pays all of her debts. She gets rid of all liens and debts against her home except the 1st mortgage, and is left without any debts except her 1st mortgage. Chapter 13 pulls this off in 5 steps (2 explained last week and summarized again, the remaining 3 explained today):
#1—“Stripping” second mortgage from her home:
Because Amy’s home is worth less than the balance she owes on the 1st mortgage, her 2nd mortgage can be “stripped” off her title. This makes her 2nd mortgage debt unsecured, so Amy doesn’t have to pay the $250 monthly 2nd mortgage payment any more. This frees up that money, adding it to the $150 per month she originally had for all of her creditors, so now there’s $400 available for creditors (beyond the first mortgage payment) each month.
#2—Chapter 13 Plan payment of $400 per month:
As detailed last week, under Amy’s plan she pays this $400 per month to the Chapter 13 trustee for about 45 months, while she brings current her 1st mortgage and property taxes, pays off her 2011—2013 income taxes, and takes care of some trustee and attorney fees.
#3—Release of IRS income tax lien:
Amy’s plan would indicate that the tax lien for the $2,500 owed for 2010 also has no equity available to it. That lien comes behind the property taxes and the two mortgages in legal priority on her title, and so has no home equity securing it, since the value of the home is entirely encumbered by the 1st mortgage debt.
So that 2010 income tax debt would be treated as an unsecured one. Since it is old enough and meets the other conditions for discharge, Amy would pay nothing on it. At the completion of her Chapter 13 case that tax debt would be discharged by the bankruptcy court and the tax lien released by the IRS.
#4—“Avoidance” of medical judgment lien:
The $5,000 judgment lien from Amy’s medical debts can also be taken off her home’s title, for a somewhat different reason than the tax lien but with the same effect. Under bankruptcy law a judgment lien which “impairs” a home’s “homestead exemption” can be “avoided,” or forced off the title. Regardless what state you are in when you file bankruptcy, your home is virtually always entitled to a “homestead exemption,” a certain amount of protection for your home against those general creditors who do not have a mortgage on your home. In essence, if your judgment amount is less than your homestead exemption, you can “avoid”—get rid of—the judgment lien. It’s pretty safe to say that the entire $5,000 judgment lien would “impair” the homestead exemption that Amy would be entitled to, so it can all be “avoided.”
Judgment lien “avoidance” is also available under Chapter 7, but there it wouldn’t have done any good in Amy’s situation. In contrast, when judgment lien “avoidance” works in conjunction with all of the other powerful tools of Chapter 13, it frees Amy’s home of one other burden, and gets her another important step towards saving her home.
#5—Continuous protection from the creditors by the “automatic stay”:
During the entire period of the projected Chapter 13 case—the estimated 45 months—the “automatic stay” would be in effect. That’s the bankruptcy law that prevents any of Amy’s creditors—especially the mortgage lenders, the property tax creditor, or the IRS, as well as the medical judgment creditor and her credit card holders—from taking any action against her or her home. In a Chapter 7 case that protection lasts only 3 or 4 months. In a Chapter 13 case it lasts the entire length of the payment plan, again about 45 months in Amy’s case.
Specifically, the mortgage lenders would not be able to start or continue a foreclosure on account of the monthly payments or property taxes not being current. The county or other governmental entity owed the property taxes couldn’t do a tax foreclosure. And the IRS could do nothing to enforce its existing tax lien, nor could it record a new tax lien for Amy’s more recent tax debts.
It’s this continuous protection that enables Amy, paying a relatively small $400 per month, to catch up on many thousands of dollars of mortgage and property tax arrearage, and income taxes, while not having to worry about her efforts being interrupted by any of these otherwise very dangerous creditors.
At the end of the 45 months or so, Amy’s 1st mortgage and property taxes will be current, her 2nd mortgage “stripped” off her home, all of her income taxes either discharged or paid in full, her IRS tax lien released and the judgment lien “avoided,” and all of her remaining unsecured debts (including the 2nd mortgage) forever discharged.
Instead of being many tens of thousands of dollars “under water” on her home, she will owe nothing on it except her 1st mortgage, so that she will be poised to build equity soon as the home’s value continued to increase. And other than her first mortgage, Amy will be completely debt-free.