I rarely advocate That clients file Chapter 13’s because they take too long and keep them under the thumb of the bankruptcy court for (usually) five years. So when does it make sense?
It makes sense when you want to keep your house but have junior unsecured liens stacked on top of the main mortgage. In Chapter 7, if you want to keep your house, you have to keep the lenders current. Not necessarily so in Chapter 13 when you have stacked loans secured by your home. Since 2006, the Heavy Question [see clever illustration below] has been: Can you dump a mortgage loan in Chapter 13? The short easy answer if you’ve ever read anything at all on my blog is that “it depends.”
First: Is it “secured” solely by your primary residential real estate? And by that I do not mean investment property or personal property. (Pay attention here because the terms and definitions matter.) That is, is the security agreement only applicable to your primary residence? If so, you have passed the first test.
Second: Is it WHOLLY unsecured? By this is meant that there is no security for the loan at all after consideration of all senior debt. Example: House valued at $750,000 With a first deed of trust (“DOT”) for $690,000, a second DOT for $170,000, and third DOT $75,000. Now what?
Well, the first is wholly secured because the value exceeds the loan balance by $60,000 ($750,000 minus $690,000.) Our hypothetical borrower can’t strip this lien because it is wholly secured.
The second is partially secured. It is secured to the extent of the $60,00 left after accounting for the first DOT right? $750,000 minus $690,00 leaves $60,000. Capiche? So because it is partially secured, you can’t strip it and the debtors will have to keep that lender current In order to keep the home.
But the third…Here’s where it gets interesting. After accounting for the first and the second, there is no security value left for the third at all. $690,000 plus $170,000 equals $860,000. But the house is only worth $750,000. Because the third is wholly unsecured, the borrower can “strip” this lien and shove the debt over to the unsecured column…Payable over the time of the Chapter 13 plan.
Why do we care? Because you can’t do this in Chapter 7. It only works in Chapter 13.
This concept as described also only works in parts of the country, so don’t go charging into your bankruptcy lawyer’s office telling him or her all about how you read on the web that you can dump your HELOC. There’s a bit more to it than the above, but this sort of scenario and fact pattern is a good example of when a Chapter 13 might make sense.