How Chapter 13 Bankruptcy Affects Mortgages and Foreclosure

Learn about the options you have to deal with your mortgage or a foreclosure in Chapter 13 bankruptcy.

By , Attorney · University of the Pacific McGeorge School of Law

If you're worried about protecting your house, unlike Chapter 7, Chapter 13 offers ways to keep it. But you must demonstrate that you have enough income to do the following:

  • afford to continue making the payment
  • catch up on arrears over three or five years
  • pay your creditors for any equity you can't protect with an exemption, and
  • make any other required Chapter 13 payment amounts.

Another valuable Chapter 13 benefit that isn't available in Chapter 7 exists. If your house is worth less than the amount you owe on your first mortgage, you can use Chapter 13 to remove or "strip" the junior mortgages. Get tips that will help you choose between Chapter 7 and Chapter 13.

Exempting Equity in Chapter 13

You don't lose property in Chapter 13 if you can afford to keep it. Each state decides the type of property filers can protect, including the amount of home equity. These figures appear in the state's bankruptcy exemptions.

However, your home equity can affect Chapter 13 and increase your monthly payment. Why? If you can't protect all of the equity with an exemption, you'll have to pay your creditors for the nonexempt equity through your repayment plan (and possibly more).

You can learn more about protecting your home in bankruptcy by researching your state's homestead exemption.

Paying Mortgage Payments During Chapter 13

To keep your home in Chapter 13, you must stay current on your mortgage. How you pay your mortgage will depend on whether you've fallen behind and the rules of your bankruptcy court.

Many Chapter 13 filers will pay mortgage lenders directly. However, sometimes the bankruptcy court and Chapter 13 trustee appointed to oversee your case require you to make your mortgage payments through your Chapter 13 plan. This payment process is most common when you owe arrearages when you file. The trustee will pay your lender each month.

Mortgage Arrearages in Chapter 13

You must pay back all mortgage arrears by the end of the repayment period, too. But you don't have to pay it all at once. You'll have three to five years to make up the overdue payments. This feature of Chapter 13 is one reason why many people facing foreclosure opt for Chapter 13 over Chapter 7 bankruptcy.

If your court requires you to make mortgage payments through the Chapter 13 plan when you're behind on your payment, catching up will be expensive. The trustee receives a percentage of the amounts paid to creditors each month. The higher your plan payment, the higher your fees and the more the bankruptcy trustee gets paid.

Chapter 13 and Foreclosure

If you are in foreclosure when you file for Chapter 13, bankruptcy's automatic stay—the order that stops most creditors in their tracks—puts a hold on the foreclosure. If you stay current on your mortgage payments and make up the arrears through your Chapter 13 plan—and you can afford to pay for any nonexempt equity—the lender can't foreclose. You'll be able to keep your home.

Stripping Off Junior Mortgages and HELOCs in Chapter 13

One of the most significant benefits of Chapter 13 is that in some instances, you can pay significantly less for your home than what you owe. If you have junior mortgages or a home equity line of credit (HELOC) that are no longer secured by the equity in your home, you can strip these loans off through Chapter 13 bankruptcy.

Before removing or stripping down a junior mortgage or HELOC, the value of your home must have declined enough so that your home equity is insufficient to cover any portion of the loan or HELOC. You can demonstrate this by getting a professional home appraisal before you file for bankruptcy. The appraisal must show that the fair market value of your house is so low that, after selling the house and paying the first mortgage, nothing would remain to pay the second or lesser mortgage holder.

To get an idea about whether you could strip a loan, start with the value of your home. If it's less than the first mortgage—the first debt secured by the house—then any subsequent or junior mortgage will be wholly unsecured. Nothing would be left to pay the junior lenders after a home sale. If, however, even a dollar remains to pay the junior mortgage, the loan isn't wholly unsecured, and it wouldn't qualify for removal.

Example. Your home is worth $475,000 and the balance on your first mortgage is $500,000 and $50,000 on the second. In this scenario, the equity doesn't secure your second mortgage. Why? Because if you sold the home, the sales proceeds of $475,000 wouldn't cover the first mortgage and would leave the second mortgage wholly unsecured. You can strip off the entirely unsecured second mortgage, and the first mortgage will remain intact (because it's partially secured).

Partially Secured Home Mortgages or HELOCs in Chapter 13

As the example above demonstrates, you can't strip off a partially secured mortgage. Suppose your home's value is high enough to pay even part of a junior mortgage out of a sale. In that case, the mortgage is partially secured, and the court won't remove the second mortgage through bankruptcy.

Example. Your balance on your first mortgage is $500,000 and you have a $50,000 second. Your home's current market value is $525,000. In this scenario, $25,000 secures your second mortgage, so you wouldn't be able to strip off the second mortgage. Here's the math: Your home value of $525,000 minus the balance of your first $500,00 mortgage leaves you with $25,000 in equity. You would have $25,000 for the second mortgage, making it a partially secured mortgage that wouldn't qualify for stripping in Chapter 13.

Procedure for Stripping Home Mortgages and HELOCs in Chapter 13

Not all courts agree on the proper method for stripping a lien from your home. Most courts prefer that debtors address the lien stripping and their Chapter 13 plan or bring a motion asking the court to strip the lien.

A few courts require debtors to bring an adversary proceeding to strip off a lien. If you file a motion or raise the issue in your plan, and the lender objects, the court will schedule a hearing where you and the creditor can present evidence.

If there is only a small difference between the market value of your home and your first mortgage, you might need a second appraisal. Or you could present additional evidence to prove the current market value of your house and that the second mortgage is wholly unsecured. The burden of proof is on you.

If the judge rules in your favor, the court will remove the lien secured by the second mortgage from your home. The loan amount will become part of your unsecured debt and be paid along with your other unsecured debt according to your Chapter 13 plan. At the end of the repayment period, the court will discharge any remaining loan amounts on the stripped-off mortgages.

Other Required Chapter 13 Payments

Before the court allows or "confirms" your Chapter 13 repayment plan, you must demonstrate that you have sufficient income to meet other required payments. For instance, you'll have to pay priority debts in full throughout your repayment plan, such as support obligations and new tax debt.

Find out more about the other debt you must pay in Chapter 13.

We wholeheartedly encourage research and learning, but online articles can't address all bankruptcy issues or the facts of your case. The best way to protect your assets in bankruptcy is by hiring a local bankruptcy lawyer.

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