In Over Your Head With A Mortgage? A Chapter 13 Might Help

If you're upside down in mortgages or other loans, you may want to know how you can get some relief. While bankruptcy might be something you prefer to avoid, you may be surprised to know that a chapter 13 can benefit you in a number of ways, including eliminating a large portion of your debt without sacrificing your home or car. If you're looking for a way out without going to extremes, here are several wonderful ways a chapter 13 bankruptcy can minimize those debts.

Understanding What a Chapter 13 Bankruptcy Does

A chapter 13 bankruptcy is also known as a debt consolidation that's sponsored by the government. But you're going to get more relief than what you'd get with a traditional debt consolidation plan. Monthly payments in a chapter 13 are determined by the amount of your disposable income, and they are made for a period of three to five years. Once that period is up, any debts still owed to most unsecured creditors are wiped clean (with the exception of certain debts like child support, student loans, etc.).   

One huge advantage of a chapter 13 over a chapter 7 is that any foreclosure proceedings must cease as soon as you file. So it's a great way for debtors to save their homes.  

Eliminating Your Second Mortgage with a Lien Strip

If you took out a second mortgage on your home, it's considered a secured debt, meaning the bank can foreclose if you neglect to pay. But with a lien strip, your second mortgage becomes an unsecured debt that gets wiped clean once your bankruptcy term is up. This is true if and only if the first mortgage exceeds the market value of the home.

For instance, suppose your home is worth $100,000. Your first mortgage might be $125,000 and your second mortgage $50,000. As a result, you're upside down by $75,000.

In a second example, suppose your home is valued at $100,000. But your first mortgage is $75,000 and your second is $100,000. You're still upside down by $75,000, right?

Yes, but in the first scenario, your first mortgage is higher than the home's market value. In this instance, a lien strip can get rid of the debt you owe on that second mortgage (or a third) once you complete the chapter 13 payments.

In the second example, you wouldn't qualify for a strip since the value exceeds the first mortgage.

Reducing Your Debt with a Cramdown

A cramdown works a little differently than a lien strip, but it's still very beneficial for a number of debtors.

If the amount you owe on a mortgage exceeds the home's value, you can reduce the amount you owe with a cramdown. A cramdown cannot be used on your primary home. But it can be used on investment or rental properties, vacation homes, cars, and debts for things like furniture and other home goods.

With this option, you're asking that the court only require you to repay the market value of the home or personal property. For example, say your car is valued at $3,000 but you still owe $8,000. You could reduce the loan to $3,000 and have it incorporated with your monthly chapter 13 payments.

As with lien stripping, you'd probably only end up paying a percentage of that $3,000 back, with the remainder owed being erased once you complete the terms of the bankruptcy.

To be approved for a cramdown, there are a few stipulations that govern how recently the property could have been acquired. For cars, the purchase must have been made at least 910 days prior to the bankruptcy. For other personal properties, they must have been bought at least one year before the bankruptcy is filed.