Rhode Island Chapter 13 Bankruptcy Blog Post

Blog posts about Rhode Island Chapter 13 Bankruptcy law

A Unique Opportunity: Second Mortgages in Chapter 13

Guest post by South Carolina Bankruptcy Lawyer Lex Rogerson.

If you’re trying to decide which approach to bankruptcy is best for you, the prospect of writing off a second mortgage can be a powerful reason to consider filing Chapter 13.

Chapter 13 carries certain disadvantages for consumer debtors as compared with Chapter 7. The fees are higher, the bankruptcy case continues for years instead of months, and the debtor usually has to pay some creditors who might get nothing if he filed Chapter 7. So there has to be a good reason to choose Chapter 13.

Traditionally the most common reason is that Chapter 13 lets debtors catch up with delinquent mortgage payments in an orderly way. But with real estate values down an average of 30% over the last few years, an increasingly common reason to file Chapter 13 is to strip off an “underwater” second (or third) mortgage.

Let’s start by looking at how secured debts are treated in bankruptcy. In Chapter 7, for the most part, secured debts pass through unaffected. If you have two mortgages when you file Chapter 7, you will almost always have two mortgages when you finish your case. You cannot strip off a mortgage in Chapter 7.

By comparison, in Chapter 13, secured debts generally are paid in full. But unsecured creditors are often paid a nominal amount, possibly as low as one to two percent of their claims. If a debt can be classified as unsecured, the debtor can likely eliminate it with a minimal payment.

Now, we typically think of a mortgage as a classic secured debt, because the creditor has a lien on the home or other real estate to secure payment. But the Bankruptcy Code has a special definition of secured debts. Under Section 506, a debt is secured only to the extent of the value of the collateral. So if I own a TV worth $200 but owe $300 on the TV, the creditor has a secured claim of $200 and an unsecured claim for the remaining $100. We refer to this as bifurcating the claim or “cramdown.”

With home mortgages, it works a little differently. In order to encourage mortgage lending, Congress has decreed that first mortgages on residential real estate cannot be crammed down. So while Chapter 13 can help you catch up with a first mortgage if you are behind, it cannot reduce the total amount required to pay off the mortgage debt.

The situation can be different for second mortgages. If the value of the property is less than the payoff on the first mortgage, the second mortgage has no remaining value to “attach to.” In effect, the first mortgage eats up all the value of the property, leaving none for the second. In this situation, the second mortgage can be classified as fully unsecured. This means the debt to the second mortgage holder, like any other unsecured debt, can be discharged, usually with only a nominal payment. We refer to this as stripping off the second mortgage.

To illustrate how this works, let’s say you have a first mortgage with a balance of $100,000 and a second of $40,000. If your home is worth less than $100,000, your Chapter 13 plan can classify the second mortgage as an unsecured debt and usually pay it off at pennies on the dollar, because the first mortgage eats up all the value in the home. But if your home is worth $100,001, the entire second mortgage survives and must be paid in full.

Because determining real estate values is not a precise matter, it is not always possible to tell for sure whether a stripoff will succeed. But the potential upside is tremendous: the debtor can emerge from Chapter 13 after three to five years with only one mortgage instead of two, and without paying a substantial amount on the second. It’s an opportunity you will want to discuss with your RI bankruptcy attorney if your second (or third) mortgage may be underwater.

One last wrinkle. If the value of the property is more than the first mortgage payoff – even if only a few dollars – this leaves some value in the property that the second mortgage can attach to. The second mortgage then gets the same protection as the first. It must be paid in full. It’s an all-or-nothing proposition. Any value beyond the first mortgage means the second mortgage survives.

RI Bankruptcy: Five Reasons to Choose Chapter 13

Because most debtors file a Chapter 7 bankruptcy and have their debts discharged within 100 days, why would any Rhode Island debtor choose a 5 year repayment plan, better known as a Chapter 13 bankruptcy? In a few limited circumstances, here are five reasons why.

Five Reasons to Choose Chapter 13

Reason 1: You Can Force the Creditor to Become Reasonable

Outside of bankruptcy, creditors are usually unwilling to restructure the payment terms. A Chapter 13 bankruptcy, however, can force an unwilling creditor to become reasonable. In a Chapter 13 bankruptcy, you can structure non-dischargeable debts, like taxes or child support, to be repaid according to what you are able to afford. Because the Rhode Island Bankruptcy Court is supervising repayment according to the revised terms, the creditor can’t take any collection action against you outside of the bankruptcy court.

Reason 2: You Can Lower the Balance Owed If You Are “Upside-down”

Many times, you may owe more money on a house, vehicle, or other secured property than the collateral is actually worth. In a Chapter 13 bankruptcy, debtors in Rhode Island may be able to reduce the loan balance to be in line with the property’s present value. This is known as a Cram Down. If your plan is approved, you can keep the property, reduce the monthly payment, and/ or change the loan terms to make the payment more affordable.

Reason 3: You Can Catch Up On Missed Mortgage Payments/ Strip-Off A Loan

A Chapter 13 bankruptcy can help a homeowner who has fallen behind on his mortgage, or is in danger of a foreclosure action. It can force the lender to accept missed payments. It may even be possible to strip off a second or third mortgage if they are essentially unsecured.

Reason 4: You May Have Bankruptcy Removed From Your Credit Report Sooner

While most debtors who file for bankruptcy can reestablish their credit quickly, a Chapter 7 bankruptcy event can stay on your credit report for as long as ten years. A Chapter 13 bankruptcy, however, will stay on your credit report for only seven years.

Reason 5: You Can Keep Non-Exempt Property

The federal and Rhode Island bankruptcy exemption laws are pretty generous and allow protection of substantial property in a Chapter 7 bankruptcy. There are times, however, that the debtor wants to keep property that is non-exempt. If the debtor is prepared to enter a 5 year repayment plan in a Chapter 13 bankruptcy, general unsecured creditors will receive partial repayment and the debtor can keep the property in question.

As I’ve stated in other articles, most Rhode Island debtors will file a Chapter 7 bankruptcy and keep all of their property. A careful analysis must be performed, however, to see if a Chapter 13 bankruptcy is a better debt solution under special circumstances.

Rhode Island Bankruptcy Information

You’ve done your best to repay creditors, but now there is not enough money to go around. Interest rates have skyrocketed, minimum payments have tripled, and you’ve fallen behind on several accounts. If you need to protect your house, your car, and stop all collection activity, will filing bankruptcy help?

If bankruptcy is the solution, will you be filing a Chapter 7 or a Chapter 13 case?

To understand the differences between these two options, let me try to paint a picture. Imagine standing outside the US Bankruptcy Court with all of your bills in hand. As your stare at the building, you notice there are only two doors to gain entrance; one door is very narrow while the second door is very wide. Its easy to see that one door is designed to keep people out and the other seems to let everyone in. Which door should you try to enter?

Well, the narrow doorway is like a Chapter 7 bankruptcy. People who earn too much income will not be able to enter and cannot file a Chapter 7 case. Only those whose gross household income (during the prior 6 months) falls below the median income (of other similar households) are permitted to file a Chapter 7 bankruptcy. A Chapter 7 bankruptcy takes 90-100 days, costs less money than a Chapter 13, and allows you to discharge most debts. Even though the doorway appears narrow, about 92% of bankruptcy filers in Rhode Island qualify and are able to enter for debt relief.

To understand a Chapter 7 case better, lets consider the following example. The median 6-month income for a Rhode Island 4-person household is presently $ 43,501 gross (0r $ 87,002 annually). If your 4-person household gross income in the past 6 months (not including Social Security income, or unemployment benefits) is lower than $ 43,501, you can enter the narrow doorway of a Chapter 7 bankruptcy. Just remember that you cannot enter the Chapter 7 doorway twice within in eight year period and time is measured from the date of your prior filing.

So what is the other doorway and why is it so wide? The second door leads to a Chapter 13 filing and is wide because bankruptcy law encourages the repayment of debt where there is ability. A Chapter 13 petition is, essentially, a 5 year repayment plan and is for those who either earn too much income, or are trying to protect property that could be lost in a Chapter 7 case. In Rhode Island, less than 10% of all bankruptcy cases are of the Chapter 13 variety.

I hope you now understand your choices a little better. It really comes down to your household income and your ability, or inability, to repay unsecured creditors. While its possible to file a Chapter 7 bankruptcy if your income is higher than the median income, I would need to perform an analysis and ask you a number of questions to see if you qualify for immediate debt relief. If you show me your pay-stubs for the prior 6 months, I can let you know your options. We can also develop a plan for filing down the road if your income is only temporarily high.