What can I do if I owe more on my home (or other real estate) than my property is worth?

Can I use bankruptcy to pay less, or reduce my payments?

In today’s world, we have seen a huge decrease in the value of many people’s homes and investment properties. Many of our clients are facing the fact that they now owe more than their properties are worth. Here are several ideas about how you can use bankruptcy to address this issue.

  • You can do nothing. If you are able to make all payments on your mortgage (and any second mortgage or home equity loan), keep making the payments. At some point the value of your home will exceed the amount due, because the value has risen and you have paid down the mortgage amount. Keep making the payments, and you keep the home.
  • If you are unable to make the payments on your first or second mortgage, one or the other can start foreclosure. The foreclosure process can take up to a year, or even longer. At the end of this process, the property is sold by a sheriff or other sales agent. If you owe more than the property is worth, the lender can seek a judgment against you for the difference, called the “deficiency.” So if your home is worth $150,000 and you owe $200,000, the lender may get a judgment against you for the $50,000 deficiency. The lender can take action to enforce the judgment, such as deducting money from your wages or garnisheeing your bank account.

There may be options such as loan modification, short sale, or deed in lieu of foreclosure.

I’ll discuss those options in another “News” article, but this article will concentrate on bankruptcy options.

  • If you want to walk away from the property and owe nothing, Chapter 7 might be a good idea. Chapter 7 is what everyone thinks of as “bankruptcy.” It’s a quick process in which you seek to discharge all your debts. There is no repayment plan and no opportunity to make any changes to any mortgage. No matter what the value of your property and no matter how much is owed, any deficiency can be discharged in a Chapter 7. Filing a Chapter 7 does not shorten the foreclosure period, and may delay it for a while. A creditor cannot take any action against the property while the bankruptcy case is pending, without asking the bankruptcy court for permission to proceed with foreclosure.
  • If you want to keep the property, a Chapter 13 repayment plan may help to adjust the payments. If you are behind on the payments but can make the payments in the future, you can bring the mortgage current over time through a Chapter 13 plan. You would resume making the regular payments each month, and pay an extra payment to a Chapter 13 trustee each month, enough to pay the back-due payments over a number of months or years.
  • In a Chapter 13, you may also be able to change the total amount due on the loan. This is where it gets interesting and a bit complicated. First, there is a difference between a home mortgage and a mortgage on other real estate (investment or rental property, for example). Second, there is a different treatment of second mortgages (and whether your loan is called a “mortgage” or a “home equity loan,” I am referring to it as a “second mortgage”), based on whether there is equity in the property after the first mortgage. And finally, the specific wording of a specific paragraph of your second mortgage can make a big difference.

Bankruptcy law treats home mortgages differently from mortgages on other real estate. When the Bankruptcy Code was adopted in 1978, Congress gave a benefit to home mortgages: In a Chapter 13, you can change the terms of any secured debt (including mortgages but also including car loans, finance  contracts, and commercial liens) EXCEPT a mortgage secured only by a lien on your home. This was to benefit home mortgage lenders, which, in the 1970s, were mostly friendly local savings and loan associations. We can ask whether the giant commercial banks that dominate the home mortgage market today still need this protection, but the law hasn’t changed.

This means that, if your mortgage is solely attached to your home, you can’t force a change of the terms on the mortgage lender in a Chapter 13. This is true whether the loan is a first mortgage or a second mortgage (although there are some instances when you can change the terms of a second mortgage, which I’ll discuss below). The lender is entitled to insist on its full monthly payment, its full interest rate, and having its payments brought current as provided in a Chapter 13 plan.

You CAN change the terms of a mortgage on real estate that is not your home in a Chapter 13. Suppose the building is worth $50,000 in a depressed market, but the loan is still at $150,000. In a Chapter 13, you can repay the $50,000 in full (with interest) as a secured claim, over time, and treat the $100,000  deficiency as an unsecured debt—like a credit card or a medical bill. You can pay unsecured debts at a percentage of what’s due—as low as 10% or even less. Again, for your home mortgage, you can’t make this kind of change.

Whether you can change the terms of your second mortgage depends on whether there is any equity in your home after the first mortgage. For example, if your home is worth $150,000 and you owe $140,000 on the first mortgage, there is $10,000 equity available to support the second mortgage. Suppose the balance on your second mortgage is $50,000. Because there is some equity to support the second mortgage, it is a “mortgage secured only by a lien on your home.” Therefore, under the bankruptcy provision mentioned above, you can’t make any changes to the second mortgage in a Chapter 13. You have to pay the full amount, though you can use Chapter 13 to catch up on past-due payments over time. But there may still be a way to change the terms of the second mortgage; read the paragraph below, starting with “Note.”

Suppose your home is worth $150,000 and you owe $160,000 on your first mortgage, and $50,000 on your second mortgage. Now there is no equity to support the second mortgage; the second mortgage is completely “under water.” In this case courts have held that your second mortgage is NOT a “mortgage secured only by a lien on your home.” It’s a mortgage secured by nothing, since there is no equity to which the mortgage attaches. In this case, the second mortgage is completely unsecured, and can be paid a percentage of what’s due—as low as 10% or even less, just like a credit card or medical bill. Your $50,000 second mortgage becomes a claim that can be paid in the amount of $5,000 (10% of the original $50,000) over time. If the Chapter 13 goes the maximum of 5 years—60 months—that’s approximately $90/month. You must make all the payments and successfully complete the Chapter 13, but at the end of the case the entire remaining balance—in this example $45,000—is discharged in bankruptcy and the lien of the second mortgage has to be released.

What about the first mortgage? In general, you can’t change the terms of a first mortgage, other than bringing payments current over time, because, no matter how bad the market has been, your home is still worth SOMETHING. If there is any value to support the mortgage—even a dollar—you can’t change the terms of a mortgage secured only by a lien in your home.

Note: (Here’s where I talk about changing the terms of a second mortgage.) Note that I keep using the phrase “secured only by a lien in your home.” This phrase is based on the language of the Bankruptcy Code. The law protects lenders secured ONLY by your home. If they have some other property securing the loan—called “collateral”—it will not be a loan secured “only” by your home, and the results in your favor can be dramatic.

I recently won a big reduction in a mortgage amount for a client in a Chapter 13 involving a second mortgage where the wording of the mortgage was very important. Without mentioning names, the case number was 13 B 47450 in the Bankruptcy Court for the Northern District of Illinois, if you want to look it up. In that case, the second mortgage lender had included a paragraph in its mortgage, somewhere around page 4 or 5, that gave them a lien on, not only the home, but also “personal property attached or affixed to the real estate.” This meant that they had a lien, at least in theory, in any bookshelves bolted to the wall, big-screen TVs attached to the wall (as they always advise us for safety), or, in this case, an electric motor bolted to the garage floor. These kinds of personal property make up collateral that is in addition to the real estate, so the lender was NOT “secured ONLY by a mortgage in the home.”

As a result of this somewhat obscure argument, we succeeded in having my client’s mortgage reduced from the loan amount of $150,000 to the $5,000 in equity after the first mortgage. This was a saving of nearly $145,000 for my client.

In conclusion, there are several options to deal with mortgages in bankruptcy. Your final choice will depend on a number of factors, including whether the property is your home or not; the value of the property; the amount due on the first and/or second mortgage; whether you are current on mortgage payments; and even on what the specific language of the mortgage document provides.

When choosing a professional services provider, it is important to choose someone with the skill and experience to handle your needs and to do the job right. As we all know experience and past results do matter. When choosing a bankruptcy or foreclosure attorney, make sure that the attorney you select is not a general practice attorney. Choose an attorney that concentrates in bankruptcy and foreclosure law. We have over thirty years of experience, and we have the skill and knowledge to help you.

Contact us for more information and we can discuss the specifics of your own situation.