Question: I own a rental property. Right now, I owe around $500,000 on the mortgage, but the state of the housing market is such that it’s only worth around $375,000. If I declare bankruptcy, will the debt be reduced to market value?
Answer: Cramdown is a tool available in Chapter 13 bankruptcy that allows you to reduce the amount you owe on a secured debt to the market value of the property. Cramdowns are not allowed on your primary residence, but you can use them for other real estate, like rental property.
This is how it works for rental property. First figure out if part of your mortgage is unsecured. That means that the value of the property is not enough to cover the loans secured by that property.
In your case, $375,000 of the mortgage is secured by the property's value (because if the property were sold at market rate, the lender would get $375,000). The remaining amount of the mortgage -- $125,000 -- is unsecured.
In Chapter 13 bankruptcy, you can get the balance you owe on the mortgage reduced to $375,000. The remaining part of the mortgage, $125,000, becomes part of your unsecured debt. It is added to the rest of your unsecured debt and paid, probably in small part, through your Chapter 13 plan.
For more details about how real estate cramdowns work, see Cramdowns of Investment or Rental Property.
by: Kathleen Michon, J.D.