Chapter 7’s Shortcomings in Saving Your Home, Solved by Chapter 13

Here’s a detailed example bringing to life ways that Chapter 7 just doesn’t help nearly enough, but Chapter 13 does.

In the last two blog posts we gave you a list of 10 major ways that a Chapter 13 “adjustment of debts” case can help you keep your home. But as well as we try to explain each of these, they make much more sense whey we show how they actually work by way of an example. So here we go.

The Example

Consider the following person, a single woman named Amy:

• She was let go from a long-time job in early 2011, did only part-time or temporary work for a long time until finally finding a decent full-time job 6 months ago. But it pays a little less than her old job.

• While she was not working full-time Amy exhausted her savings and then, because she felt she had no choice, used her credit cards to make mortgage payments. She currently owes $20,000 in credit cards.

• After maxing out her credit cards Amy fell $6,000 behind on her first mortgage and $2,500 behind on her second. Those mortgage lenders are both threatening to foreclose.

• She has not paid her last annual property tax bill of $2,250. Her first mortgage lender is demanding she pay this in full immediately, because this jeopardizes its own security in the home.

• Amy had some medical issues while she was between jobs and had no health insurance, so she owes $5,000 in medical bills. A collection agency sued her a few months ago, so she now has a $5,000 judgment lien against her home.

• Amy owes $2,500 to the IRS for 2010 income taxes, interest and penalties. She couldn’t make her monthly installment payments, and so the IRS recently recorded a tax lien against her home.

• She also owes the IRS $2,000 for each of the 2011, 2012, and 2013 tax years, a total of $6,000, because money was so tight those years of irregular work that she didn’t have enough taxes withheld.

• Amy’s home was worth $320,000 back before the Great Recession, lost about 30% of its value, and is now still only worth about $250,000. She owes $265,000 on the first mortgage, with monthly payments of $1,100 (with insurance and property taxes), and owes $45,000 on the second mortgage, with monthly payments of $250.

• She hopes to stay in her home because she has a son who started high school last year, he is doing well there, and she would not be able to find other affordable housing within the same school district.

• Amy now has a pretty reliable income. After she pays modest but reasonable living expenses, she has $1,500 available each month to pay ALL her creditors, including the two mortgages. That’s only $150 per month beyond the two regular mortgage payments, nowhere near enough to pay all her debts. In summary they include:

  • credit cards: $20,000

  • 1st mortgage arrearage: $6,000

  • 2nd mortgage arrearage: $2,500

  • property tax arrearage: $2,250

  • medical debt judgment lien: $5,000

  • 2010 income tax with tax lien: $2,500

  • 2011, 2012, and 2013 income tax: $6,000

That’s a total of $44,250, besides the $265,000 first mortgage and the $45,000 second mortgage.

What Would Happen in a Chapter 7 “Straight Bankruptcy”?

If Amy filed a Chapter 7 case, that would help her somewhat by discharging (legally forever writing off) tens of thousands of dollars of her debts. She would most likely no longer owe any of the credit card debts, nor the judgment from her medical debts, nor likely even her 2010 debt to the IRS (although that is complicated by the lien on her home securing that tax debt).

But discharging these amounts, totaling $27,500, would not be nearly enough to enable to keep her home. It still leaves her with mortgage and property tax arrearages totaling $10,750, plus $6,000 in income taxes that a Chapter 7 case would not discharge (because they are too recent). With just only $150 to spare after paying the current first and second mortgage payments, that’s way too small to even begin to satisfy her mortgage holders and the IRS.

So after Amy’s Chapter 7 case would be completed (only about 3 or 4 months after its filing), at some point her home would be foreclosed because of the mortgage and property tax arrearages. The IRS would likely attempt to collect the 2011-2013 income taxes through garnishments of her paychecks or bank accounts, and likely new tax liens recorded on her home, if she still owned it at the time.

Clearly, Chapter 7 doesn’t help Amy meet her goal of keeping her home.

Chapter 13 Salvation

But if Amy instead filed a Chapter 13 case, under these same facts she would actually be able to keep her home. Before her case was over, she would be able to get completely current on her home obligations, including the property taxes, and she would either discharge or pay her tax obligations. She would do all this while she, her paycheck, her home and all her other assets were protected from future tax liens and any other collection efforts by any of her creditors. At the completion of her case she would be completely current on all home obligations and be otherwise completely debt-free.

How could she do all that with only $150 to spare in her budget? Through some powers that are available only under Chapter 13. I’ll describe how they work in Amy’s situation in my next blog post.