Kentucky Bankruptcy Law

Counsel with Care

Second Home Loans: Disappearing debt

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.

September 26, 2014 Posted by | Assets, Bankruptcy, Chapter 13, Exemptions, Foreclosure, Plan payments, Pre-filing planning, Property (exempt | , , , , , | 1 Comment

Car Cares and the Chapter 13 Dilemma

While I often extol the virtues of Chapter 13 bankruptcy, there is one issue in them that can be most vexing to a Debtor in need of help. Nearly every Chapter 13 Debtor owns a car with a secured debt attached to it when they file. Previously I have talked about the benefit of being able to reduce the interest rate on high interest car loans through the Chapter 13 and even, when the debt is old enough, cram down the principal owed to the actual value of the car. These all remain true. However, there is a hidden danger to having a car loan in Chapter 13.

The danger lies in 11 USC Sect. 1235(a). This provision lists a number of things that must be true about a Chapter 13 plan for it to be confirmed. Conversely, if all the requirements of 1325 are met, the court must confirm the plan. Shaw v. Aurgroup Financial Credit Union, 552 F.3d 447 (6th Cir., 2009). The Sixth Circuit Court of Appeals has issued case law based on this code provision that severely restricts the flexibility of a Chapter 13 bankruptcy in this one area of car loans. Those decisions are In re Adkins, 425 F.3d 296, 300 (6th Cir.2005) and In re Nolan, 232 F.3d 528 (6th Cir.2000).

Essentially, these two court opinions determine that once a plan is confirmed and the car lender’s claim is allowed, then it shall always be a secured claim. This may not sound formidable, but here is how the scenario plays out: Debtor has a car worth $7,000.00 which is working okay at the start of the plan. The plan gets approved and the secured claim is filed by the lender for $7,000.00. Perhaps there is another claim for excess debt on the car that is treated unsecured, but that does not matter in this situation. A couple of years into the plan, the car starts messing up and it becomes more costly to fix than the car is now worth. The Debtor, who is paying all their disposable income into their Chapter 13 cannot get the car fixed. So, they seek to modify the plan, surrender the car, and purchase a more roadworthy vehicle. They can only manage this if they can reduce their plan payment. They can only reduce their plan payment if the deficiency of the car loan, what’s left after the car is surrendered and auctioned, is unsecured debt. However, In re Adkins and In re Nolan preclude this.

That $7,000.00 cannot be re-characterized as unsecured. Let’s say the loan after two years of payments through the Chapter 13 plan is now $6,000.00 but the car auctions only for $1,000.00. That leaves a $5,000.00 deficiency. That $5,000.00 remains a secured debt that MUST be paid in full during the remainder of the Chapter 13 plan. The Debtor still must pay the exact same amount in plan payments and thus cannot afford to buy another vehicle. Now they have no car but they still must pay for their surrendered car in full.

The Sixth Circuit used solid statutory construction and policy considerations in coming to this result. They wanted to keep a Debtor from being able to enjoy a car for a while and then shift the depreciation value to the creditor. However, because the creditor knows they will be paid in full regardless of what they do, they have no incentive to realize the actual fair mark value of the car that was surrendered. The Debtor cannot sell the car due to the lien in place and the because of the Chapter 13 bankruptcy so they are stuck. They might as well keep the car and make do for the life of the Chapter 13.

The main point in all of this is to do a careful assessment of one’s vehicles and car loans prior to filing. Going into a Chapter 13 with high value cars that also have a high debt load can leave one with almost no wiggle room for the life of the Chapter 13. It would be best surrender such vehicles prior to confirmation of the plan and obtain an inexpensive used car prior to filing. And, if they have cars with debt, the Debtor needs to have some comfort that the car will actually last the life of the bankruptcy.

March 3, 2014 Posted by | Uncategorized | , , , , , , , , , , , | Leave a comment

Consolidation loan conundrum

I had a consult scheduled with a potential client recently who did not make it in. No worries, I just reached out to her to see if she wanted to reschedule. She declined because she had initiated a consolidation loan process to pull together all her outstanding unsecured debts under one, lower interest rate. She was getting this consolidation loan by refinancing her house and using up any equity in the house to secure the loan. I still offered to meet with her – for free even though I likely would see no business result from the meeting. I did not want to talk her out of this plan; I simply wanted to make sure she had full knowledge of all the ramifications. This is because I know people who have done this successfully and avoided bankruptcy. I have known others who did this and it ended up putting their home at risk.

Essentially, a consolidation loan like the own my potential client was wrangling does not reduce debt principal. It usually does reduce interest costs over the lifetime but, to be sure of this, one must factor in the closing costs and fees associated with an equity loan secured by your house. What does happen is that unsecured debt gets converted into secured debt. Secured loans offer lower interest rates because the risk of total loss on the loan is mitigated by the value of the property securing the loan. In other words, if you do not pay they take your house.

A bankruptcy, whether Chapter 7 or Chapter 13, shreds off most or all unsecured debt. So, in a bankruptcy situation, unsecured debt is good debt to have because you will not have it long. Secured debt does not pass away so quietly. You can sever the personal obligation to repay the debt, but there are only very narrow avenues by which the secured obligation – the liability on the property – can be done away with. An equity line on a house can only be completely discharged in a Chapter 13 IF there is absolutely zero equity to which the loan actually adheres.

So, if my potential client does follow through with this secured consolidation loan, then she has closed off the possibility of shedding that debt unless she sheds the house as well. This may be a great strategy. She may have enough income that is reliable enough to make that extra house payment and still meet her living expenses. I just want her to know that doing so commits her to that one way out of debt and to make that decision with as full knowledge as she can get. And, if it works out, I am glad for her. If it does not work out, well – perhaps I can still help her save the home with a Chapter 13.

December 3, 2013 Posted by | Alternate Debt Relief, Bankruptcy, Chapter 13, Chapter 7, Consolidation loan, Discharge, Planning, Pre-filing planning, Security interests | , , , , , , , , , , , | Leave a comment

Objecting to a claim in a Chapter 13 100% payment plan

I spoke previously about objecting to a claim filed in a Chapter 13 bankruptcy as it relates to “cramming down” or “stripping off” secured debt. In that article I explained the role of creditors’ claims, so I will not elaborate on that here. A more pressing reason to object to a claim filed is if your Chapter 13 plan calls for unsecured creditors to be paid in full. This is referred to as a 100% plan.

I suppose the first thing to explain is why anyone would bother filing bankruptcy if they can pay their creditors in full. Essentially, Chapter 13 bankruptcy forces all creditors to play ball by the same rules. It puts each creditor on the same footing within their class. If you have one creditor who is pursuing a lawsuit or post-judgment collection activities, such as wage garnishment, the debtor may not have the resources to work things out with other less aggressive creditors. The debtor essentially enters into a “debt” spiral because they can only deal with one or a few creditors at a time instead of a global resolution of debt with all creditors. Chapter 13 stops the debt spiral and makes that one or few aggressive creditors operate under the same plan as all the other creditors. So, a 100% plan can allow a global resolution of debt in an orderly fashion rather than a rush to the courthouse by aggressive creditors.

Another benefit to the 100% Chapter 13 plan ties in with the one just discussed: payments can be spread over five (5) years. A debtor who could not afford to make large payments to a creditor that demands being paid in full in just one year very well be able to afford to pay in full over the five year period of a Chapter 13 plan. An additional benefit is that people are facing interest rates that of 29% (usurious in my opinion), but under a Chapter 13 payment plan unsecured creditors cannot demand payment of the post-petition interest. Along these same lines, the debtor may have fallen behind on secured debt payments, such as their house payment. Their mortgage company may demand payment in full immediately or they will foreclose on the property. Under the Chapter 13 plan, the arrearage can be spread over the plan period.

So, a 100% Chapter 13 plan can provide for the orderly resolution of debt, halt exceedingly high interest rates, and avoid the spiral of debt. This brings up to the reason for objecting to claims in a 100% plan: you can also pay off a 100% plan early! Simply put, if you have $50,000.00 in unsecured debt, but only $30,000.00 worth of claims are filed, the Chapter 13 payment that would resolve the debt in full over five years may allow you to be finished in only three years. This gives impetus to examining creditor claims closely in a 100% plan, because if some of amounts owed are inflated or unsupported, an objection could allow you to be done early with your bankruptcy.

March 14, 2011 Posted by | Bankruptcy, Chapter 13, Plan, Plan payments | , , , , , , , | 1 Comment