Chapter 13s last either three (3) years or five (5) years depending on a households income at the inception. That is quite a long time and it can be easy to let it fade into the background of one’s mind after settling into the rhythm of monthly payments to a Chapter 13 trustee. A debtor in a Chapter 13 likely had considerable contact with their attorney at the very beginning of the case, but this becomes less and less frequent after the plan is confirmed and all the claims have come in. After a couple of years, some old habits can creep back in, and the debtor may never think to contact their lawyer when faced with certain financial decisions.
Many of my Chapter 13 clients come to me to help save their home from foreclosure. A Chapter 13 is a grand tool for just such a thing. Most of these clients got to the point of facing a foreclosure action in State court because they made choices between paying a house payment and getting needed car repairs or paying for a necessary medical procedure. That first time of missing the payment, they likely started getting some calls, but nothing earth shattering happened. Next thing they knew, several missed payments have racked up, they are served with a civil summons, and the only way to catch them up is through a five-year Chapter 13.
Then Christmas rolls around that second year into the Chapter 13 and the belt-tightening budget worked out with the trustee really only left room for macrame’ gifts for the children or perhaps a Chia pet or two. It is heartbreaking for a parent when their children’s friends are getting the newest iPhone or PlayStation 4. Perhaps the car broke down again or the refrigerator they had been nursing along for an extra 10 year lifespan finally goes out. Well, that old pattern kicks in and it seems pretty harmless to miss a house payment. After all, nothing bad happened before until a good six months down the line. Well, bankruptcy is a different world.
Most home loan creditors will file a motion for relief from the automatic stay (the law that precludes them from going ahead with the foreclosure once bankruptcy is filed) with just one or two missed payments post-petition. Being in Chapter 13 basically puts them on high alert and they are much quicker to pull the trigger.
This is not the end of the world – yet. Their attorney can object to the motion and almost always work out an Agreed Order to get caught back up again in about six (6) months. However, there is a hefty price to be paid. The creditor will add in their own attorney fees and they will also likely insist on a drop-dead provision where if those payments do not roll in on time, the stay will be lifted without filing another motion and they can then proceed with the foreclosure.
The better course of action is to call one’s bankruptcy attorney to do some problem solving when an unforeseen expense comes about. In the Eastern District of Kentucky, the Chapter 13 Trustee typically does not oppose a motion to suspend plan payments for a month or three if there is a good reason. That is often enough to get past some unexpected expense and get back on track making up the payments. The upside to this is that the debtor will not get hit with hundreds more in attorney fees or end up on a probation sort of situation. So, even if it has been a long time since you talked to your bankruptcy attorney, if things go awry, call them first and get help.
Well, I cannot actually make a second mortgage disappear, but I might be able to strip it off of your house and make it an unsecured debt instead of a secured debt.
In a Chapter 13, one can “value” the amount of a secured debt under 11 USC Sect. 506. Essentially, when one files a Chapter 13 a secured debt is only secured up to the value of the property it is secured against. There are some exceptions which I will not go into. If you own a home and have a second mortgage, then that second mortgage might be completely underwater. That is, there is no equity left to which the secured debt can attach. If that is the case, it can be “stripped” off of the property and treated as an unsecured debt.
However, if the lender can prove that there is even $1.00 worth of equity, the courts in the Sixth Circuit (including Kentucky) will not strip the loan off; it has to be paid in full to keep the house just like the primary loan. The rationale is that as one pays down the principal on the primary loan, more and more equity is realized to which that second loan can attach.
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.
The trustee’s office appears to be taking a closer look at expenses in Schedule J of Chapter 13 cases. Specifically, they appear to be pushing for decreasing recreational/entertainment expenses and miscellaneous expenses. Previously, this trustee’s office tended to utilize the standardized amounts provided for in the means test as a gauge. As a result, if a debtor reported a particular expense in excess of those amounts, I would encourage them to engage in “belt-tightening” in that area.
The interesting thing about those standardized expenses is people who make less money have lower expenses while people who make more money have higher expenses even when the family size is the same. In the prior approach, the trustee’s made some allowance for this dynamic. The trustee’s current approach seems to be to cram those relatively higher income families into the expense structure of the lower-income Chapter 13 families. Now, even if expenses fall within the standard allowance of the means test, the trustee is looking for deeper cuts.
On the surface, this seems fair – after all, why should richer people get to have higher expenses and still discharge their debts at the end? The problem comes down to human nature. Once people develop a set point of expenses, then it is extremely hard for them to do substantial cuts in those expenses. When one is talking about the extended timeframe of five years in a bankruptcy, well the likelihood of successfully maintaining extensive cuts drops dramatically.
So, what is the goal of Chapter 13? I suggest that we are best served when people successfully complete Chapter 13 plans. This will not happen when budgets are made so tight as to be unwieldy over time. Debtors will get into a tight spot with unexpected expenses and be unable to make their payments. This is not to suggest that people should get to engage in lavish lifestyles in a Chapter 13; rather, I suggest a balance between belt-tightening and sustainable budgets. Clothing makes for a good analogy: a really tight dress may look really trim and neat, but no one can wear it day in and day out. Rather, one needs slightly roomy clothes to go about their day-to-day business. Such an approach will increase Chapter 13 successful outcomes and, thus, increase the overall return to unsecured creditors.
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.
Last post explained some of the issues the debtor had to be aware of in purchasing a car prior to filing a Chapter 13. Today I want to complete that discussion with two other considerations. The first is really a concern for the creditor who sells the car. Timing matters in the perfection of the lien on the title of the car to make the car debt a secured one. Under 11 USC Sect. 547(e)(2)(C)(ii), the seller of the car has up to 30 days after the filing of the bankruptcy to perfect their lien. Perfecting a lien means that they get notice of the lien on the title of the car. A lien must be perfected to be enforceable or not avoided. The reason this matters mainly for the creditor is that if the creditor fails to perfect the lien within 30 days of filing the bankruptcy then they cannot get paid in full AND yet they cannot repossess the car. Essentially, they become unsecured creditors only and they only get pennies on the dollar.
Although that impairs the creditor, the of ways this impacts the debtor, though, is that extra litigation is practically guaranteed to get the lien removed from the title later on. Despite this extra work, the debtor would still have to pay the same plan payment whether that car debt is secured or not. So, it is just cleaner to allow plenty of time (at least 30 days) for the creditor to get that lien perfected.
The second way it impacts debtors for a lien to go past this deadline to be perfected has to do with exemptions. Suddenly, if the lien is not properly perfected, then the whole value of the car must either be exempted or the non-exempt part may increase what has to be paid into the Chapter 13 plan. A Chapter 13 plan must propose at least an equal amount of payments that go to unsecured creditors exists in non-exempt assets. So, when “wild car” exemption plus the vehicle exemption fall short, the plan payment might have to be increased.
Often, when approaching a Chapter 13, a legitimate concern that the potential debtor faces is having reliable transportation during the Chapter 13. The debtor may have fallen behind and had a car repossessed just prior to the bankruptcy filing. Or, more commonly, they are driving a junker of a car that is on its last legs (or wheels). Considering that most Chapter 13 bankruptcies are for five years (some people qualify for a three-year Chapter 13), having a junker car at the start is problematic.
First, it is very hard to predict how much one will have to expend to keep a junker car running for five years. Second, although debtors can apply to the court to incur additional debt during a Chapter 13, it is a tad more complicated to buy a car during the Chapter 13. So, it is entirely legitimate planning to buy a car prior to filing the Chapter 13. If there is sufficient disposable income, buying a dependable car before a Chapter 13 can direct some of that income away from paying unsecured debts towards paying for a legitimate need of reliable transportation. After all, transportation allows for employment and having regular income is necessary for a Chapter 13.
If, after talking to your lawyer about it prior to Chapter 13, you decide to buy a car then there are some things to be careful about. Foremost, you want to buy a car that is reasonable. Forget the Rolls Royce or Jaguar and look for the Corolla or Focus. In other words, do not get a luxury vehicle but get one that is functional. Now, it does not have to literally be a Corolla or a Focus, but the idea is to minimize fuel and repair costs while having enough car to meet your families needs.
Second, you need to be aware of the timing of the purchase. Under 11 USC Sect. 546(c)(1), the seller of goods appears to be allowed to have a right to reclaim the car within 45 days (or 20 days of the petition date if within that 45 days). There appear to be no cases in the Sixth Circuit addressing this issue, but it has come up elsewhere. In one case from Alabama I reviewed, the seller of the car claimed 546(c)(1) gave them the right to take the car back and moved the court to lift the stay to do so. Ultimately the court ruled in favor of the debtor because they found no exception for reclamation in the automatic stay of bankruptcy for the seller, but who wants to go through the hassle of unnecessary litigation. So, if possible, it is best to make the purchase 45 days prior to filing the bankruptcy.
One of my clients recently asked about selling a vehicle and using the proceeds to pay off the plan early. Because they had been paying the car off through the plan, they had reduced the principal considerably. However, it just was not that simple. The only funds that can be used to pay off a Chapter 13 earlier are exempt funds. The car did have some equity at the start of the case so there was approximately $600.00 exempt equity in the vehicle. But, from there it gets tricky.
First of all, during the Chapter 13, all the property the Debtors had at the start of the bankruptcy remain assets of the estate. The Chapter 13 trustee does not routinely “abandon” property of the estate the way that Chapter 7 trustees do. So, one must file a motion with the court to sell property. My clients could have done this easily enough, but they would also have to successfully amend the exemptions to cover all the equity that now existed, which is problematic in and of itself.
The most common way Chapter 13s get paid off early are from withdrawals from retirement accounts that were exempted at the beginning of the bankruptcy.
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.
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