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Chapter 13 and Foreclosure

What You Need To Know

 
  • Chapter 13 Allows Homeowners Time To Pay Delinquent Mortgage Payments 

    A chapter 13 bankruptcy, also called a wage earner's plan, enables individuals with regular income to consolidate their debt and develop a plan to repay all or part of it.  The debtor makes monthly installment payments to a chapter 13 trustee who then distributes payments to creditors.  After three years of payments, five years for above-median income debtors, the debtor is released from all dischargeable debt. 

    Like a chapter 7 bankruptcy, filing a chapter 13 petition stops foreclosure proceedings but a chapter 13 also permits the homeowner to cure delinquent mortgage payments over time.  All debt payments, including a portion of the past due amount as well as the current monthly mortgage payment, must be timely paid otherwise the debtor may lose the home.  Payments on the mortgage arrearage must go through the trustee, but if permitted by the court, current payments can be paid by the debtor directly to the lender.  The debtor's regular payments to the trustee, will require adjustment to living on a fixed budget for a prolonged period.  Moreover, while confirmation of the plan entitles the debtor to retain property as long as payments are made, the debtor may not incur new debt without consulting the trustee.

    At the end of the plan, the discharge releases the debtor from all debts provided for by the plan.  But there are debts that cannot be discharged in a chapter 13, including certain long term obligations (such as a home mortgage), debts for alimony or child support, certain taxes, debts for most government funded or guaranteed educational loans and benefit overpayments among others.

    Debtors who complete their chapter 13 plan, emerge from bankruptcy with their homes still in their possession, their mortgage payments caught up and their unsecured debts discharged.  Though their mortgage payments remain the same as they were before filing bankruptcy, they are in a much better financial position to maintain their mortgage payments.


  • A Debtor Can Strip-Off Unsecured Junior Mortgages In A Chapter 13
     

    Another useful feature of a chapter 13 that can have major consequences for the right homeowner, is that it allows wholly unsecured second and third mortgages to be reduced to unsecured debts and therefore to be paid off at pennies on the dollar in the chapter 13 plan.

    The first mortgage holder on a home is usually the bank that loaned the money to originally purchase the home.  A chapter 13 debtor cannot modify the rights of the first mortgage holder.  A junior mortgage is any mortgage filed after the first one and is usually a home equity loan or line of credit.  It is when the home value falls below the first mortgage balance, that the junior mortgages can be stripped off.  If there is not enough equity in the home to secure the junior mortgage then the bankruptcy judge can reduce it to unsecured debt.

    Note that the junior mortgage must be totally underwater before it can be stipped off.  What becomes critical is the valuation of the home, for if there is one dollar of equity that can be applied to the junior mortgage it cannot be stripped off.  For example, if a homeowner has a $100,000 first mortgage balance and another $50,000 on a home equity loan, and the home value has dropped to less than $100,000, the judge could rule that all $50,000 of the second is unsecured.  Unsecured debt is then paid off at a very small percentage of the debt owed in a chapter 13 plan.

  • Bankruptcy's Effect On Your Credit Report

    Filing either a chapter 7 or 13 will impact your credit score in the same way, but how much of an impact depends on your entire credit profile.  For example, someone with spotless credit can expect a huge drop in their score, whereas some argue that someone with many negative items on their credit report may even see a slight boost in their credit scores after filing bankruptcy.  Credit scoring by FICO® divides consumers into 10 groups and ranks the consumers in each group based on the others in the group.  Post-bankruptcy consumers are placed in a bankruptcy group where their credit score may see long-term improvement based on a comparison to others in that group. 

    A chapter 7
    remains on credit reports for ten years, while all other black marks including a chapter 13 disappear after seven years or less.  Declaring Bankruptcy frees you from paying all or part of the debt you owe, but it does not erase bad credit history.  Instead of being deleted, accounts will be updated in your credit report to show “included in bankruptcy.”  Experts agree that your credit score will benefit if you can dig yourself out of debt without filing bankruptcy, but one has to be realistic about one's ability and your credit score alone should not be the deciding factor whether to file bankruptcy.


  • The Cost of Bankruptcy

    Bankruptcies are complicated and usually too difficult for debtors to file on their own without an attorney.  Bankruptcies are also expensive both in court costs and attorney fees.  For a chapter 13 filing, the costs include a $235 case filing fee and a $46 miscellaneous administrative fee.  For a chapter 7 filing, the costs include a $245 case filing fee, a $46 miscellaneous administrative fee, and a $15 trustee surcharge.  Debtors whose annual incomes are at or below 150% of the Federal Poverty Level ($17,235 – 1 person, $23,265 – 2 persons) and who are not able to pay the chapter 7 filing fee in installments, can ask the court to waive the fee altogether.  Chapter 13 fees are not waivableAdditionally, a discharge will not be granted until the debtor has completed an approved course in financial management from a credit counselor, which costs between $50 and $100.

    Attorney fees for filing a chapter 7 average around $1,250, but can vary significantly between metro and rural areas.  Also a factor is whether the case is a simple "no asset" case or complex
    one that may involve litigation.  A chapter 13 is a more complex filing and attorney fees average around $3,000.  But because a chapter 13 attorney fee can be included as part of the repayment plan, an attorney may take your case for no money up front other than the court costs and take his attorney fees in small monthly installments as part of the chapter 13 plan.

    Because attorneys fees must be disclosed in a bankruptcy filing just like all other debts and assets, it is possible to research the fees that any bankruptcy law firm or attorney charges by visiting the PACER website and doing a party search.  The cost is eight cents per page viewed.  You can also search PACER by bankruptcy district, which will give you a cross section of the fees charged in your area.  You will find attorney fees listed at item number nine on the bankruptcy Statement of Financial Affairs (pdf) form.

    When dealing with legal issues it is always recommended that debtors consult an attorney for legal advice.  If you cannot afford an attorney call 1-866-Law-Ohio (1-866-529-6446) or visit OhioLegalServices.org for your closest legal aid office.
Tax Consequences

The Tax Consequences of Foreclosure - A Video

In this five minute video, attorney Melissa Skilliter, Director of Southeastern Ohio Legal Services Low Income Tax Clinic, explains the tax consequences of foreclosure.


Whether To File Bankruptcy May Depend On Tax Consequences

If you discharge a debt in bankruptcy, you do not owe tax on it.  Though forgiven mortgage debt is also generally not taxable, you may fall into an exception and if you do, filing bankruptcy may save you thousands of dollars.

Section 202 of The American Taxpayer Relief Act of 2012, extended through 2013 the Mortgage Forgiveness Debt Relief Act of 2007 for homeowners or sellers who have a portion of their mortgage debt forgiven by their lender. 

This extension means homeowners will be excused from paying taxes on forgiven mortgage debt through 2013.  Typically when mortgage debt is forgiven because of a short sale, deed-in-lieu or foreclosure sale for sellers or a mortgage modification for owners, the lender will send the homeowner a 1099-C, Cancellation of Debt form listing the amount of debt forgiven.

Without the legislation’s extension, any debt forgiven would be taxable income, which, for underwater households, can be a financial burden in the thousands of dollars.  In order to establish the non-taxability of the discharged debt with the IRS, the homeowner or seller must file the long form 1040 and attach Form 982.  See IRS Publication 4681 for more information.  Note that you may still be liable for state taxes on the amount of debt forgiven in the short sale or deed-in-lieu transaction.  See a tax professional for more information.

However, this forgiven debt is non-taxable by the IRS only for money specifically spent on the home purchase or improvement.  Many homeowners refinanced mortgages or took out home equity loans to fund vacations, pay college tuition, and buy cars or boats.  If forgiven, that debt is taxable because in IRS terms, debt resulting from the refinancing is qualified principal residence indebtedness only to the extent it refinances debt that had been secured by the main home and was used to buy, build, or substantially improve the main home. 

If you will owe state and federal income tax on your forgiven debt, a bankruptcy discharge may save you money.

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This website provides general legal information and not legal advice.  The law is complex and changes frequently. 
Before you apply any general legal information to a particular situation, consult an attorney. 
If you cannot afford an attorney call 1-866-Law-Ohio (1-866-529-6446) or visit OhioLegalServices.org for your closest legal aid office.

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