Earlier this year there was much debate regarding the possibility of amending the bankruptcy code to allow for judicial modification of first mortgages on a Chapter 13 debtor’s primary residence. This is referred to as a judicial “cramdown.”
The “cramdown” provision would enable judges to bifurcate the total mortgage debt of a Chapter 13 debtor’s principal residence into the amount secured by the real estate at the current market value while treating the balance owed on the mortgage as a general unsecured debt like credit cards and medical bills. This proposal was significant in that it would allow for principal reduction which has been the hot button topic throughout the economic downturn and the real estate-mortgage crisis.
Unfortunately, the cramdown legislation did not pass so under the current law there is no mechanism that gives bankruptcy judges the tool to modify a Chapter 13 debtor’s first mortgage on their primary residence. The current law prohibits stripping or modification of first mortgage liens on a Chapter 13 debtor’s primary residence. However, in many bankruptcy districts, including the Middle District of Florida, which encompasses both Manatee and Sarasota counties, you can modify or “lien strip” a second or other subordinate mortgage which is not supported by any value in the property over the amount owed on the first mortgage.
Under the current bankruptcy law, a second mortgage that is completely unsecured can be stripped and reclassified as unsecured in a Chapter 13 bankruptcy case and, in most cases, paid only pennies on the dollar, while the homeowner keeps the home! The caveat is that the debtor in Chapter 13 must complete the plan in order to benefit from this action.
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For example, if your home is worth $300,000 and your first mortgage payoff balance is $325,000, you have no equity. The debtor can further solidify their assessment of the value of the real estate by getting an appraisal of the property. Let’s say that you have a second mortgage with a loan balance of $50,000. This second loan is a wholly unsecured mortgage and would be paid from the same pool of money as all other unsecured creditors within the bankruptcy case. If, however, the home in this scenario is worth $330,000, you cannot strip off the second mortgage lien because it is merely undersecured. In other words, if the second lien is partially secured you cannot remove it.
This lien stripping tool may be helpful to homeowners with home equity lines of credit secured by a second mortgage on their primary residence or homeowners that purchased the home using the 80/20 loans with the simultaneous second mortgage funding that enabled borrowers to get 100 percent financing. If such a lien is stripped in a Chapter 13, it can be treated as an unsecured debt in the Chapter 13 plan and paid the dividend amount provided for all unsecured claims over five years. The second mortgage holder would be paid only a fraction of the total amount of the loan.
The actual amount paid to each unsecured creditor as a portion of the whole debt owed to that creditor or dividend in Chapter 13 will depend on several factors. The first factor is the value of the debtor’s non-exempt assets that would have been available for administration by the trustee if the debtor had filed a Chapter 7 bankruptcy petition instead. In addition, the plan must take the debtor’s disposable income into account as well as the proposed payment to secured creditors and those creditors holding administrative or priority claims. These claims have priority of payment before the unsecured creditors begin to receive payment through the plan. Unsecured creditors are typically the last to be paid through a Chapter 13 plan.
Cynthia A. Riddell, an attorney whose practice primarily focuses on bankruptcy, real estate foreclosure, short sales as well as other debt related matters, can be reached at (941) 366-1300.