You home is an incredible source of collateral for loans when there is equity (value minus debt secured against it), but there is also danger in using your home this way. There are still lenders who will do rather large, short-term loans secured against a private residence. These loans can be tempting because they often will provide for relatively low-interest loans. However, they can be dangerous. especially when they are balloon loans. Such loans are seductive because they have low monthly payments with a final huge payment due at the end.
I have seen these often used by people trying to get a business venture off the ground. However, people sign up for them for many reasons. The business folks are essentially betting on having a solid and very profitable business going in three to five years. I admire their confidence, but most businesses that survive take three years just to start making a modest return. And so, many find their balloon payment looming without adequate resources to cover the debt. Sometimes banks will roll it into a new loan, but there is no guarantee of this. Therefore, it is wise to talk to a lawyer who knows about bankruptcy prior to that maturity date.
Banks like loans against your personal residence because the revisions to the bankruptcy code back in 2005 gave special treatment to loans secured solely against one’s residence. Basically, 11 USC Section 1322(b)(2) prevents such loans from being modified in a Chapter 13 bankruptcy. Therefore, the only thing one can do is cure the arrears through the bankruptcy, but the underlying agreement remains intact. There is a nice little exception, though, found in 11 USC Section 1322(c)(2) for loans that come due DURING the Chapter 13. So, if one times things right and files a Chapter 13 BEFORE the last payment on your short-term loan is due, a Debtor CAN modify that loan to some extent.
The most likely use for this exception is to move the maturity date of the loan out for the duration of the Chapter 13 plan and thus provide for the cure of arrears on that loan. The Debtor still has to show that the lender is adequately protected, but that hurdle is usually overcome easily with real estate that is either holding its value or increasing in value. This is NOT a complete remedy, but it can buy more time for a Debtor to either find alternative financing that has no balloon payment or make those profits they hoped for that would cover the debt.
Since I do not focus on a volume practice in bankruptcy and because I have become known as someone who is able and willing to tackle some unusual situations, I get to consult with debtors that have really tough circumstances. A recent case led me down a path of seeing just how creative I could be in a bankruptcy situation to forestall and ultimately pay their home loan lender. Anyone who has talked to me or read many of my posts know that I am quite fond of Chapter 13 bankruptcies. This is partly due to the flexibility afforded by them to accomplish many things, such as saving one’s house from foreclosure. So, I fully expected to find that a Chapter 13 would be the best vehicle to solving this client’s issue where they were nigh on losing their home.
In the scenario presented to me, the debtor had a sizable asset they had not been able to touch which was in trust but not much in ongoing income. The trust was not a spendthrift trust, or else we would not even venture far down this path. However, the debtor hoped that in bankruptcy, the trust assets could be obtained in order to pay their debts – likely at 100%. There are many twists and turns to this matter which I simply cannot go into here. Negotiating this one particular twist will just bring us to another turn and so the analysis is far more complicated than I am putting forth. Other issues involve the couple being unmarried and looking at who actually owns what. There are issues related to the automatic stay when a foreclosure has already been granted, but on appeal. And, just how tight the trust actually is will determine much. However, this particular issue I am focusing on may be helpful to others. In theory, the debtor’s notion of satisfying their debts with this currently unattainable asset is appealing.
We must look at 11 USC Sect. 1322(b)(8) to start the analysis. This section allows the plan proposed by the debtor to provide for payment of all or part of a claim from their property or property of the estate (let’s not worry about that distinction too much – it is often one and the same, but not always). The debtor can do this, in part, because under 11 USC Sect. 1306(b), the debtor remains in possession of all property of the estate. In other words, if you have property you cannot cover with exemption and you really want to keep that property, the way to be assured of that and file bankruptcy is in a Chapter 13. In a Chapter 7, what you cannot exempt is subject to being liquidated.
So far, so good – the debtor keeps the trust assets and keeps the house. Oh, but then we have to look at other provisions of the code. Next, we turn to 11 USC Sect. 1325 which requires that they are able to make payments. If my debtor’s only means to make payments on the plan is accessing their trust, then we run into a problem because there is no reasonable certainty that they will get into that trust in bankruptcy. After all, they were unsuccessful before considering bankruptcy. Because of this uncertainty and the absence of regular income, the plan may not get confirmed. The second barricade the debtor hits is the dreaded “adequate protection” called for in 11 USC Sect. 361. If they cannot protect the secured creditor’s interest in the Chapter 13, then they have no right to keep the asset securing the debt. In essence, this is a carve out of the Section 1306 provision.
Oh, but the secured property is land which typically increases in value; it does not decrease in value. However, in our situation, the amount owed on the property is far more than the value of the land under current market conditions. Still, we may be able to show adequate protection if we show that the value of the land is increasing faster that the debt is accruing interest and other allowed charges. Let us leave this one alone then, since it is driven by things I do not wish to get mired in.
The real problem I find myself up against is caused by the very provision that usually helps people out so much in a Chapter 13: Section 1306. When we combine the fact that the debtor keeps possession of their assets with the other nicety of Chapter 13s: the debtor has an absolute right to convert to a Chapter 7 or dismiss their Chapter 13 case, that is where get to the rub. My debtor cannot show that she can and will make payments to unsecured creditors as required by Section 1325 when she could dismiss the case as soon as she gets hold of the trust assets. Such a plan is unlikely to get confirmed.
Only if her income could pay an amount equal to the non-exempt asset could she get confirmed because there is one other hurdle not yet mentioned. The final hurdle is back in Section 1325 which basically says that creditors have to come out at least as well as or better than if the debtor filed a Chapter 7. This is the creditor’s “best interest” test that balances out the debtor’s benefits in Chapter 13s. In our case, if the debtor filed a Chapter 7 which cannot be converted dismissed without permission and where the assets of the estate go into the trustee’s hands, my debtor cannot pass this test.
Oddly enough, given many facts that I did not go into, this case is actually one where Chapter 7 gives a better likelihood of saving the house. The trustee would be vested with the ability to crack open that trust and has more resources with which to do it than the debtor in a Chapter 7. And, if successful, the home loan would still likely be paid in full even after the commission and other expenses.
I was wrapping up final preparations on a Chapter 13 petition and proposed plan today for filing next week. As I ran through the plan and made provisions for the adequate protection payments (in this region they are typically 1% of the value of depreciating assets), I realized it would be some time before I began getting paid for my work. You see, in a Chapter 13, one can put much of the attorney fees into the plan to be paid as administrative costs. This is a priority class of creditors that can be paid in full through the course of the plan. As a priority class, that also means they can be paid ahead of many other kinds of debt.
However, they do not get paid ahead of adequate protection payments. I had been very diligent in this person’s plan to make their budget workable so they could keep their family running while still saving their house and paying off the family car. That car, a family vehicle worth over $10k, meant that adequate protection payments would be over $100 per month right out of the gate. However, due to repaying some retirement plan debts (allowed to avoid tax penalties) their first several months of plan payments would not be much more than the adequate protection amount.
I breathed a sigh and reassured myself that it was just a matter of time and I would be compensated for the post-petition work. I felt good that I was helping the family and that they would be able to cover the arrears on their house and stave off foreclosure. And, I made a mental note that in the future I needed to be mindful of high value cars and tight budgets so that I asked for a smidgen more in up front fees on such matters.
This is a round about way to explain why, in discussing a Chapter 13 with your attorney, she or he may seem to waffle a little on the attorney fees. There is a $3,500.00 “no-look” fee in the Eastern District of Kentucky. This does not mean that is a set, required fee. Rather, if your attorney charges that much or less, the court is not going to ask your lawyer to prove up the time she or he spent as an attorney. If more is charged, then an application detailing the work must be produced. Most attorneys will charge the $3,500.00. Where the waffle comes in is how much will be required to be paid up front prior to filing. I tend to go on the low-end because I know things are so tight for people and I make it as affordable as a Chapter 7, but I have to off-set that with the demand of my own expenses.
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