August 18, 2017

Chapter 13 Bankruptcy for Second Mortgages

road arrow directionHomeowners who are in financial difficulty are well advised to consider a Chapter 13 bankruptcy case as an option when they are current on their first mortgage but are not paying, in full and on time each month, their second mortgage (including a home equity loan or other debt secured by the property).

I see situations where people whose incomes have been cut will forego paying the second mortgage while staying current with the first. When they are able to resume payments on the second mortgage balance but the mortgage company is unwilling to modify their mortgage so that they can catch up on the missed payments, Chapter 13 is a court-supervised way to accomplish the goal.

(Mortgages are actually called “deeds of trust” in North Carolina, but we’ll use the term mortgages here.)

I have dealt using Chapter 13 to help homeowners catch up on missed mortgage payments (first and second mortgage payments) in other posts.

Three options in Chapter 13 for a second mortgage

There are three options for a second mortgage in a Chapter 13, where the debtor is current on the first mortgage:

1. Get caught up on the second mortgage through bankruptcy plan payments. The second mortgage arrearage, as of the date of the filing of the bankruptcy petition, is paid back in full through the plan payments, over time.

Chapter 13 cases typically involve proposing a plan to pay back creditors over sixty monthly payments (five years); a debtor can propose a plan to pay what’s owed as of the date of the bankruptcy filing back, in sixty monthly installments. At the same time, the debtor must make each current mortgage payment.

For example, if a Chapter 13 case is filed on October 1, 2011, and as of that date, the borrower is past due on a total of $12,000.00 in second mortgage payments, then the debtor can, through a Chapter 13 bankruptcy case, pay the $12,000.00 back over sixty months, but must at the same time pay each and every month all mortgage payments (first and second). Thus, in October, the debtor must pay his or her October 2011 first and second mortgage payment PLUS the Chapter 13 payment, a portion of which goes to paying the pre-petition second mortgage arrearage. This goes on for sixty months (the life of the Chapter 13 case).

2. Surrender the property and discharge the debt that is secured by it.  Sometimes, borrowers either simply cannot afford to pay second mortgage arrearages in a Chapter 13 case (see above) while at the same time remaining current on their mortgages, or decide not to make those payments because the debt exceeds the value of the property (it is “underwater”). These situations often cause a borrower to decide to give up (surrender) the property in a bankruptcy case and discharge the mortgage debts.

Depending on the borrower’s overall financial situation, the borrower may qualify for Chapter 7, discharging the debt and making no payments to the mortgage lender —or, be limited to a Chapter 13, discharging the debt and paying a fraction of what’s owed to the mortgage lender (the payment depends on the debtor’s individual financial circumstances).

The mortgage lenders will eventually foreclose on the surrendered property, and their recovery is limited to (a) the proceeds realized from the foreclosure sale and (b) any payment through the Chapter 13 plan. Because the property is being surrendered as part of the bankruptcy case, the mortgage debts are treated as unsecured (because the house goes through foreclosure) and are paid the same amount as credit cards, medical bills, and other unsecured debt, according to what the plan proposes that unsecured creditors be paid (generally less than 10 cents on the dollar, but the plan payment depends entirely on each borrower’s financial situation).

3. Strip the second mortgage through an adversary proceeding in the Chapter 13 case.   This is a complex subject, covered here. 

Evaluating the various ways of dealing with mortgaged real property is too complex for a blog post. This one is designed to give you hope for a solution that is monitored by the federal bankruptcy courts and that your mortgage lenders will probably not tell you about. Call a qualified bankruptcy attorney.