Chapter 7 provides limited help if your home is encumbered by a statutory lien. Instead Chapter 13 may significantly reduce what you pay.
Our last two blog posts have been about statutory liens on your home. We’ve gotten into what they are, and the trouble they can cause both without and even within bankruptcy.
The main trouble statutory liens cause under Chapter 7 “straight bankruptcy” is that they survive to live on afterwards. The debt secured by the lien may be forever written off but the lien continues to attach to your home.
So under Chapter 7:
- an income tax lien recorded on your home continues on even if the underlying tax qualifies for discharge (legal write-off)
- a construction/mechanic’s lien stays on your home even if the debt to your contractor upon it is based is discharged
As a result these liens continue to be on the home’s title. You’re largely left on your own to deal with them, usually without a clear legal mechanism to do so. Sometimes these liens can be foreclosed, forcing you to pay off the lien to prevent loss of your home. More often they just continue encumbering your home until you sell or refinance it. So you have to pay off the lien then, taking a chunk out of your proceeds of sale or refinancing.
Chapter 13 Advantage with a Fully Secured Lien
The main advantage you get in Chapter 13 is protected time, if you have to pay the lien in full. That would usually happen either if the underlying debt is one that bankruptcy does not discharge or if there is enough equity in your home making the statutory lien fully secured.
So under Chapter 13:
- If the IRS recorded an income tax lien on a tax that does not qualify for discharge so you must pay it in full, you have up to 5 years to pay it, on a flexible payment schedule based on your budget, and making room for your other important debts.
- If your home has a construction/mechanic’s lien and plenty of equity to cover it, you have up to 5 years to pay it, again on a flexible schedule.
So, you pay off these liens that you must pay to keep your home, but do so on your terms. You and your home continue to be protected from the creditor throughout the repayment period. You’re not left exposed to potential foreclosure and other collection pressures. At the end of the Chapter 13 case you will have paid off the debt and the lien. You and your home will be free of both.
Chapter 13 Advantage with a Partially Secured Lien
Save money by paying only the secured portion of the debt. If you have a statutory lien in which the underlying debt is dischargeable, and there’s enough home equity to cover only a portion of the lien amount, Chapter 13 enables you to focus on that secured portion.
So under Chapter 13:
- Assume you own an income tax debt old enough so that it qualifies for discharge. Many recorded tax lien are on such debts. Assume that the debt and lien is for $20,000 but you have only $5,000 equity in your home. Your Chapter 13 plan pays the $5,000 on a flexible payment schedule. The remaining $15,000 is treated as a general unsecured debt. That means you pay it only as much as you can afford to do so during your 3-to-5-year payment period. That’s often only pennies on the dollar, and might even be nothing.
- Under similar facts with a construction/mechanic’s lien, you’d get the same favorable results.
As a result of paying only the secured portion in full, you can save a lot of money. The creditor doesn’t get the benefit of your home’s increasing equity into the future. The creditor loses the ability to pressure you into paying the entire debt. This is a usually a much less stressful, less expensive alternative.
Chapter 13 Advantage with a Completely Unsecured Lien
If there’s no equity in your home to cover any of the statutory lien, a Chapter 13 filed through your bankruptcy lawyer effectively turns that lien’s debt into an unsecured one. That’s a huge advantage. The lien loses virtually all of its power. The debt gets lumped in with the rest of your “general unsecured” debts. That often means you pay very little of that debt, and sometimes nothing at all.
So under Chapter 13:
- Assume the same facts as above: a $20,000 income tax debt that’s dischargeable, with a recorded tax lien. But this time your home is completely underwater—you owe more in your mortgage(s) than the home is worth. Your Chapter 13 plan treats the full $20,000 as unsecured. If your plan pays the “general unsecured” debts 20%, you will pay only $4,000 of that $20,000. If your plan pays 5%, you’ll pay only $1,000. And if your budget and your court allows a 0% plan, you’d pay nothing on that $20,000 tax debt.
- Under similar facts with a construction/mechanic’s lien, you’d get the same very favorable results.
As a result of effectively “un-securing” the statutory lien, you can often save a tremendous amount of money. The creditor loses virtually the entire benefit of its lien. All you have to do is successfully complete your court-ordered Chapter 13 payment plan. At its completion you will have paid whatever portion of the effectively unsecured debt as required. Then the rest of it is discharged along with all (or most) of your other debts. The statutory lien must then be released. You and your home are free and clear.
NOTE: Your ability to do the above may depend on where you file your bankruptcy case. Even though bankruptcy is a federal procedure, there are variations in interpretation among regions of the country and by particular bankruptcy judges. Get counsel about all this from your local experienced bankruptcy lawyer.