When You Should Avoid Using Chapter 13 to Save Your Home
Chapter 13 provides awesome tools for hanging onto your home. Yet sometimes Chapter 7 is enough and better.
Chapter 13 and Your Home
Chapter 7—sometimes called “straight bankruptcy—is much simpler and takes much less time than Chapter 13, the version of bankruptcy with a three-to-five-year court-approved payment plan. But Chapter 13 can help in so many ways with home-related debts that people who are behind on their mortgage or have other kinds of liens on their home tend to leap to that option.
In upcoming blogs I’ll talk about all the many ways that Chapter 13 can help. But to give you a taste of them, some of the main ones include:
1. More time to catch up on any back mortgage payments: Chapter 7 gives you a limited amount of time, usually a year at the most, to catch up. Chapter 13 often gives you years, which greatly reduces how much you have to pay each month to eventually get current.
2. Stripping second or third mortgage: Under Chapter 7 you have to simply pay any junior mortgages. Chapter 13 gives you the possibility of “stripping” a second or third mortgage lien off your home title, potentially saving you hundreds of dollars monthly, and thousands or even tens of thousands of dollars in the long run.
3. The flexibility that comes from getting extended protection from your mortgage holder(s): Chapter 7 gives you at most only about three or four months while your mortgage holder can’t foreclose and your other creditors can’t take action against you or your home. In contrast, under Chapter 13 you could potentially be protected for years. This can often give you creative ways to meet your goals, such as letting you delay selling your home for several years.
4. A good way to catch up on any back real property taxes: Filing a Chapter 7 case doesn’t protect you from property tax foreclosure—beyond the three, four months that the case lasts. Chapter 13 protects you and your home while you gradually catch up on those taxes, in a court-approved plan that also incorporates your mortgage(s) and all other debts.
5. Protects your home from previously recorded and upcoming income tax liens: Chapter 7 usually does nothing to address tax liens that have already been recorded on the home, or to stop future tax liens on income taxes that you continue to owe after the bankruptcy case is completed. In contrast Chapter 13 provides an efficient and effective procedure for valuing, paying off, and getting the release of tax liens. And the IRS/state cannot record a tax lien on income taxes while the Chapter 13 case is active.
That may all sound pretty good (and there’s more). But still, Chapter 13 may be neither necessary nor appropriate in your situation.
Consider Chapter 7 Instead of Chapter 13 When Chapter 7 is Enough
If you are behind on your mortgage payments, but could realistically catch up within about a year, you may not need the stronger medicine of Chapter 13. If you could catch up after writing off all or most of your debts in a Chapter 7 case, and by being financially very disciplined for that one year, that would likely be the wiser way to go.
Most mortgage lenders will negotiate a “forbearance agreement” with you after you file a Chapter 7 case, allowing you to stay in your home and to catch up on your mortgage arrearage by paying a certain amount extra per month. How much time you will have to get current on your mortgage depends on your lender’s practices, your payment history with that lender, and other related factors.
Considering the benefit of getting to your fresh start in a year or so, instead of three to five years, be sure to carefully discuss with your attorney whether solving your mortgage arrearage problem through Chapter 7 looks feasible. Of course also look at all the other advantages and disadvantages of these two options in light of all the rest of your financial circumstances.
Consider Chapter 7 When Chapter 13 Will Not Likely Do Enough
As powerful as Chapter 13 can be, it has its own limitations regarding home debts. For example, it does not have the ability to reduce your first mortgage payment or mortgage balance. It can’t reduce your annual property taxes or discharge (legally write off) any property taxes. And if you subsequently cannot maintain the payments you agree to in your Chapter 13 plan, you could very well lose the protection against foreclosure and other collection efforts against you.
Especially if your home is under water—you owe on it more than it’s worth—try to think practically about whether the effort to keep the property will be worth the effort. Even if you do have some equity in the property, if you are really going way out on a limb to catch up on the mortgage arrearage and other debts related to the home, carefully consider whether you will really be able to pay what you are arranging to pay. If you pay a bunch of extra money over the course of a year or two only to not be able to maintain the necessary payments and lose the home, you could waste a lot of your time, money, and effort.
As you honestly discuss with your attorney your financial goals, consider whether filing a Chapter 7 case and letting your house go would actually be a better way to meet your (and your family’s) real needs. Chapter 13 should not be a last-ditch long-shot. Be honest with yourself that you may be trying to hang onto a house that you won’t be able to even with all the help that Chapter 13 can provide.