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.
Chapter 13 is an extremely effective legal mechanism for saving one’s house if it is being threatened with foreclosure. The trend these days is for home loan lenders to refuse to accept payments while “modifications” are being “reviewed”. This means arrears mount higher and higher. I have known of an extremely few home loan modifications actually coming to fruition. However, I have heard person after person recount to me how the lenders “lost” paperwork submitted for modifications multiple times, countless delays, requests for more information, and ultimately refusal to modify. This whole process can destroy the chances of a Chapter 13 to save your home.
In a Chapter 13, the entire arrears on a house have to be paid in full during the 60 months of the plan duration. The arrears can include certain fees, penalties, and other costs prior to the filing, but gets zero (0%) percent interest in the plan in the Eastern District of Kentucky. So, if the arrears mount too high prior to filing the Chapter 13, then the plan payment can end up being so high that the plan is not feasible. On top of the plan payments, one has to resume making the ongoing regular monthly payment.
I strongly recommend that you consult a bankruptcy attorney about a Chapter 13 early in the process because modification efforts are usually unsuccessful. I do not know why lenders are taking the approach they are to home owners because it does not seem economically logical, but then we are talking about huge, mindless organizations. But, in a Chapter 13, the lenders HAVE to play by the rules.
Debtors also must play by the rules and they MUST make those monthly payment to the lender and their Chapter 13 plan payments for the whole thing to work. So, their budget must support both payments. This means taking action early.
A couple of days ago I wrote a post about refinancing your home loan during an active Chapter 13. In that post I addressed the issue of how such refinancing impacts your budget and plan payment. You need to think long-term in refinancing, because your will not be able to hold onto the savings from the lower mortgage payments. This is aggravating, but benign.
There is a much more sinister trap that refinancing can land you in. You need to be careful when looking at refinancing within an active Chapter 13 as to how to any existing arrears on the original loan are treated. If you are paying substantial arrears through the plan, but refinance, then those pre-petition arrears are most likely to be paid off with the new loan. Essentially, a lender with arrears is not going to release their lien to allow a new lien to take priority over theirs until all sums due are paid. This includes those arrears.
If that happens, then your plan payment is still going to be just as high or higher depending on your new loan payment. But, where a certain amount of those payments were going to pay off the arrears at zero (0%) percent interest, now you will be paying interest on the same arrears in the new loan. Not only that, but the percentage of your plan going to unsecured creditors will likely increase significantly. This may all be fine with you if your heart’s desire is to pay as much of your debts as possible. However, it needs to be a conscious decision rather than one your stumble into.
So, if you are paying $10,000 in arrears at 0% interest in the plan on the original loan and then refinance, the $10,000 arrears gets “paid” from the proceeds of the new loan. Your principal is now $10,000 higher than on the original loan, but your plan payment stays the same or higher. You essentially just cost yourself $10,000 plus interest. Your may not feel it, though, because the actual month to month cost remains relatively stagnant.
When looking at refinancing, it is best to look at all factors to make a wise decision: new interest rate and savings from that, length of time left on mortgage, amount of arrears in the plan, and how much additional interest you will pay if the arrears are then out of the plan and in the new note.
Interest rates on mortgages can vary considerably during the lifespan of the average Chapter 13 bankruptcy, that being five (5) years. For example, rates on fifteen (15) year fixed home loans were down below 3.5% interest recently. The traditional rule of thumb I have heard on refinancing is that if you can cut your interest rate by one percentage point (1%), then it is worth the closing costs to pursue it. This refinancing is NOT out of reach for a Chapter 13 debtor.
Even though in bankruptcy, a Chapter 13 debtor has a decent chance of finding a lender who will refinance their home loan while the bankruptcy is still pending. They will require an Application to Incur New Debt to be made and they will only approve the loan is an order approving the application is entered by the court. The courts will typically approve these applications if your Chapter 13 is in good standing and the debt appears to be manageable.
However, there are other ramifications to keep in mind. First, if the refinancing of the loan decreases your monthly loan payment made directly (outside the plan) to the lender, then your budget is affected. That means your will also have to file an amendment to your Schedule J expenses. If the change is significant, you may be required to modify your plan payment and pay the savings your realized into the plan each month.
This may be discouraging because you refinanced to save money each month and then that very savings still has to get paid out; you do not realize any of the savings. So, it must be a long-term gain to make it worthwhile during the Chapter 13. If you have several years to pay on the mortgage beyond the Chapter 13, then it will be worthwhile.
There is a second ramification to be careful of, though, and this one is potentially very costly. I will write about that one in my next post.
I had a voice-mail this morning that caught my attention (more than usual that is). It was from a woman who had consulted with me several months ago. In the voice-mail she confessed that she had filed the bankruptcy with another attorney. I was tempted to erase the message and move on with my day. After all, I typically spend about an hour on my initial consults without charging and now this person wanted more of my limited time.
However, I decided to take the high road on the matter and I called her. As it turns out, she went with another attorney who charged less to file her bankruptcy. Now, though, when she was having trouble with her home lender the attorney she chose would not respond to her calls and emails. I figured it was impolite to ask exactly how much less she paid for her bankruptcy, but she readily acknowledged that she wished she had paid a little bit more and gone with me.
Her dilemma was that she was going through a divorce and the home lender would not talk to her even though she is on both the deed and the mortgage to the house. I explained that there are three documents involved with a home loan and the one she was not aware of was the promissory note. Even though she was on the deed and the mortgage, the promissory note was the one that actually created the loan and she likely was not a signatory to that document. That would be the only explanation for what she was describing.
So, after fifteen plus minutes she thanked me and told me I was the first person she had talked to who could explain what was going on. I gave her some options for how this scenario would play out in the divorce and encouraged her to stay with her current divorce attorney. For payment of my time, I asked her to recommend me to others and go ahead and explain that I might cost a tad more, but I would be worth it.
I routinely tell people in my consultations that if they call around they will find attorneys who charge $100 or even $200 less for a Chapter 7 filing. I also explain that if they price shop, they need to also be asking what they get for that price. When I file a Chapter 7 for someone, I figure I am in it through the *whole process and I make it my business for the bankruptcy to go as smoothly as possible. If that costs $100 or so more, I figure it is nothing in comparison to the tens or even hundreds of thousands of dollars in debt I am helping them get a fresh start from.
So, is this bragging? Perhaps. However, they only way I can compete when a potential client is looking for a rock bottom price for a Chapter 7 is to give information – if I matched prices and still did the same quality of work I would be filing bankruptcy for myself. My hope is that many potential clients will be smart purchasers of legal services and be able to compare services offered as well as price.
* There are unusual circumstances that I explain in advance where a contested matter or adversary proceeding might arise and require additional fees, but I do a good job of being thorough and point those out when there is a risk of them.
We grow very attached to our homes. There is such a long heritage of home ownership being part of the American dream. Many who immigrated here long ago could have never attained to being a land owner and the new life in America created the opportunity and hunger for this hallmark of the gentry in the old country. This latest recession took a huge swipe at that American dream and one of the hardest parts of my job is helping a debtor realize when they just cannot hang onto their land.
The most common way this plays out is when a home owner has done all they can to stay on top of debts in the face of dwindling resources. They seek out a home loan modification to stave off financial devastation. Most lenders, though they are not required to do so, insist that the home owner stop making payments while they “process” the paperwork. This creates a bind, though, because almost no one sets that money aside to cure the arrears in the event the modification fails. And, once that payment is missed, then lender has the right to accelerate the mortgage and foreclose.
Chapter 13 is a great tool to save a home because it forces the lender to allow arrears to be paid, without additional interest, over 60 months. But, they home owner debtor must show they can afford the payments needed to pay the ongoing loan obligation PLUS pay enough plan payments to cure the arrears. There comes a point for each debtor where the arrears simply surpass their ability to catch them up in that 5 year window. When this point is reached, I am forced to give them the news that they cannot revive their home; it is too late. Some receive the news and surrender to the inevitable and others refuse to believe they are out of options.
The important thing to do if you have arrears mounting on your home loan debt, is to get solid bankruptcy counsel early on. When you allow time for planning, the chances of saving the home are maximized.
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- “I’ve Changed My Mind – I Want to Surrender My House”: What Effect Does Post-Confirmation Surrender Have on the Debtor’s Discharge?
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