Crucial Question: Can You Give Examples of Some of the Main Benefits of Chapter 13?

We end this series on Chapter 13 with some illustrations of how it works and why it can be so great.

 

Curing Home Arrearage

If you are behind on your mortgage payments, especially enough so that you are being threatened with foreclosure, catching up can be almost impossible. If you file a Chapter 7 case, usually you’ll get at most a year or so to catch up. If you are many thousands of dollars behind, that’s not nearly enough time.

Here’s how it works instead under Chapter 13:

Harry and Sally fell 10 payments behind on their $1,750 mortgage while Sally was unemployed. With her new job, they can now afford their monthly mortgage payment. But if they discharged (legally wrote off) in a Chapter 7 case their other debts–credit cards racked up to make ends meet during Sally’s unemployment and medical debts that piled up while she wasn’t insured—they would only have about $350 per month to pay towards the $17,500 mortgage arrearage. Paid over the course of a full year, that would only make a small dent in that arrearage, and would not satisfy their mortgage lender, who would instead finish foreclosing on their home.

Under Chapter 13, however, Harry and Sally would be able to stretch out the time for curing the mortgage arrearage for as long as 5 years. $350 per month paid into their Chapter 13 plan would be enough to accomplish that. Their mortgage lender would have no choice but to allow Harry and Sally the opportunity to do so. At the end of their Chapter 13 case they would owe nothing on the credit card and medical debts and would be current on their mortgage.

With “Cramdown” Keep a Vehicle That You Could Otherwise Not Afford to Pay

Under Chapter 7, if you need to keep a vehicle on which you’re making payments, most of the time you have no choice but to “reaffirm the debt”—legally commit to paying the full debt, including the full monthly payments. It doesn’t matter if the vehicle is worth much less than you owe on it, or if you are not confident that you can maintain the monthly payment throughout the rest of the months and years of the contract. You risk having the vehicle be repossessed later, at which point you would likely owe thousands of dollars to the creditor in a “deficiency balance,” regardless of your recent bankruptcy filing.

Here’s how it works instead under Chapter 13:

Jake has a vehicle loan more than 910 days old (about 2 and a half years), owes $20,000 on that loan, with monthly payments of $550, on a vehicle now worth only $12,000. If he filed a Chapter 7 case, in all likelihood he would have to “reaffirm” the $20,000/$550 per month vehicle loan—that is, make a legally binding agreement to exclude that vehicle loan from the Chapter 7 discharge of debts. However, under Chapter 13 “cramdown” Jake would only have to pay in full the secured portion of the vehicle loan, $12,000 based on the value of the vehicle, and likely at a lower interest rate. He would not need to pay the remaining unsecured portion–$8,000—except to the extent he had extra “disposable income” during his Chapter 13 plan to do so.

So through “cramdown” Jake would be able to reduce his vehicle monthly payments from $550 to about $275 over a term of about 4 years. At the end of that time he would own the vehicle free and clear, having saved at least $10,000 in payments and interest.

Second Mortgage Lien Stripping

Generally, real estate mortgages and liens survive bankruptcy. If you have a first mortgage with a debt larger than home’s value, and owe a second mortgage as well, a Chapter 7 bankruptcy filing would not affect either the first or second mortgage liens. If you wanted to keep the home, you’d have to pay both mortgages.

Here’s how it works instead under Chapter 13:

Jessica owns a home that used to be worth $350,000 just before the real estate crash of 2008-09. The home’s value hit bottom at $250,000 about three years ago and has been climbing slowly so that it is now worth $280,000. She owes her first mortgage lender $295,000, with a monthly payment of $1,275, and her second mortgage lender another $35,000, with a monthly payment of $300.

Since Jessica’s first mortgage debt is larger than the value of the home, leaving no equity to secure the second mortgage, under Chapter 13 that second mortgage lien on the home’s title can be “stripped” off the title. This converts that debt into a “general unsecured” one, so that she would no longer need to make the $300 monthly payments. The balance on that second mortgage debt would only have to be paid as much as Jessica could afford to do so during the course of her Chapter 13 case. In all likelihood it would be paid only pennies on the dollar. Then at the end of her case the remaining amount would be discharged (legally written off). Then Jessica’s home would be encumbered only by the first mortgage. As a result, if property values would continue increasing she would begin to build equity in her home much earlier, about $35,000 earlier.

 

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