Cross-collateralized Loans in Bankruptcy

I have talked in here before about the risks involved in doing all your banking with one institution. What I am cautioning against is having your bank accounts with the same institution where you have a car loan, home loan, and signature loan or any combination thereof. To explain one of the reasons to avoid this, I will describe a common scenario: Debtor buys a car using their bank or credit union because of the rates or because of the ease of doing business in the same place. Later, Debtor needs a little extra cash and so they take out a signature line of credit. The bank is eager to offer this line of credit and even gives Debtor a lower interest rate so long as they cross-collateralize the loan against the car. Of course, it is no longer really a signature loan, but a secured loan but we will call it “signature” for convenience.

Debtor ends up having to file bankruptcy and they want to keep their car. Let us say the car is worth $5,000.00 and the purchase loan balance is $7,000.00 with the signature line of credit being another $3,000.00. Debtor qualifies for a Chapter 7 and their budget shows they can afford the payments to reaffirm on the $7k loan, but it is too tight to be able to also reaffirm on the $3k loan. Here is the problem: the bankruptcy court will be reticent to approve a reaffirmation where you are promising to pay back two loans instead of just the purchase money loan AND where your budget does not support it. Your lawyer would be a bit foolish to sign off on such a reaffirmation, but their signature promises that they have reviewed it and that reaffirming both loans would not create a hardship, when clearly it would be a hardship. So, it the reaffirmation has to go to the judge for approval.

The bank is holding all the cards here because that second loan, even though it is a non-possessory, non-purchase money security interest under 11 USC 522(f)(1)(B), is not one that can be stripped off in a Chapter 7 because it is secured against a car rather than household goods or the like. So, to go into a Chapter 7, the Debtor has to decide what is most important and what they can let go of. The Debtor has to play a financial game of chicken and say to the credit union to either let them just pay the purchase money loan alone and keep the car or come on and pick the car up (not literally, there are motions to be filed). Some banks will cut their losses and at least get paid for the purchase money part, but others refuse to make deals believing it makes them look weak.

There is one other option: Chapter 13. If the car was purchased more than 910 days prior to filing bankruptcy and the second loan was incurred more than a year before filing, then great things happen. Under provision 11 USC 506 and 11 USC 1325(a)(hanging paragraph), then the purchase money debt of $7k gets crammed down to the $5k value of the car and the $3k non-purchase loan gets stripped off as an unsecured debt.

To figure out what the best approach is going to be in this circumstance, your attorney will need to look at a lot of different factors and advise you as to the best course of action.

Issues with surrendering real estate

Reality has set in. The home loan modification you so desperately hoped for fell through after they strung you along for months (“Just keep making the payments during the trial period” or “Your application is being processed, just keep paying”). Your budget is so tight that even in a Chapter 13 your would not be able to pay off the arrearage on the loan for the house and you can take Chapter 7 according to the means test. It is now unavoidable that you will not be able to keep the house and so you tell your attorney to check the “Surrender” button for your intentions on your principal residence. It feels like surrender too, but not entirely in a bad way. Surrender also means the fight is over and the fresh start of debt free living can begin. But, what do you do with the house now?

Some people feel compelled to get out of the house as quickly as possible. It is a desire to get going on that fresh start by getting the old out of the picture and finding a new place; renting an apartment where they will not be reminded of the lost home. Sometimes it is because of a fear that someone will show up unexpectedly and toss you and all your stuff out on the lawn (which won’t happen unless you have some in-laws that are also outlaws and mad at you). Lastly, sometimes it is just a sense of guilt for staying someplace and not paying for it. I understand those driving emotions, but I caution you to sit tight for as long as possible.

Before I explain why you should sit tight, I need to revisit a core principle of Chapter 7. This type of bankruptcy establishes a single point in time where everything you owe and eveything you own goes into a fictional pot called an estate. Then, you use exemptions and reaffirmations to pull assets back out of that pot that you want to keep while leaving most debts behind. Once that point in time is created, everything you earn and every debt you create after that moment remains yours; new assets and new debts do not go into the estate. So, what does that have to do with a house I have surrendered? Aren’t my debts on that house going to be discharged?

Well, yes, those loans you had that were secured against the house will likely be discharged (barring any kind of pre-filing fraud or other bad acts that can prevent a discharge). However, you have a nice, tempting, empty piece of property just sitting there inviting neighborhood kids, hoodlums and other roustabouts to come in and have at it. However, your name remains on the deed for the house until after the Master Commissioner sale is confirmed or your provide them a quitclaim deed. Because this is all AFTER you filed your petition, you are liable for potential debts that could arise as the titled owner of the house.

If someone were to be injured on your property after the filing of the Chapter 7, you could get hit with damages from the injury. Additionally, the mortgage holder of the property could make a case for damages done to the property itself that decreases its value or for the insurance policy they obtain (I’m not saying they would be successful, but who wants the aggravation and expense of finding out if they would be?). You could propably afford to pay the insurance premium on the property if you are not paying the house payment, but home owner’s policies usually become void or voidable if no one resides in the house for over a certain period of time. So, there are several reasons to remain in the house until either the Master Commissioner’s sale is confirmed or a quitclaim deed is filed transferring ownership of the house.

Here is a recap of those reasons:
1) You are potentially liable for injuries that occur on property you still have title to after the Chapter 7 is filed.
2) You will have a hard time getting insurance coverage on an empty house (though there are specialty companies that do this for a high premium).
3) An empty home is an open invitation to high risk behavior that can lead to injury.
4) You are in financial dire straits and living there while not paying the house payment can help you get ahead and find a nice place to move to once the ownership is transferred. Yes, it may feel uncomfortable, but not as uncomfortable as having a post filing debt and not being able to get another discharge for a number of years.

So, plan on staying in your surrendered home for several months even after filing Chapter 7. If you must move, negotiate transferring title to the mortgagee while the bankruptcy is pending.