The real estate boom of the late 1990’s and early 2000’s caused a super inflated valuation of both property and the attached mortgages. Many individuals and families anxious to assume their place in the American Dream became homeowners with substantial debt, rising interest rates and skyrocketing balloon payments through adjustable rate mortgages (ARMs). When the economic floor fell out from underneath them, many homeowners couldn’t bear the financial burden and fell behind in their mortgage payments and other debts. Many afraid to talk with their lenders are facing foreclosure as the only option available. What they and others like them should know is that there are other alternatives if quick action is taken.
Unfortunately, when finances become grim, many individuals delay in the hopes that the situation will improve leaving time as their enemy. What many don’t know is that if the homeowner has significant equity in the home – typically 15-25% – and is less than 90 days past due, there may be a variety of options available to prevent foreclosure.
These can include:
- Loan Modification and/or Refinancing
- Chapter 13 Bankruptcy
- Strip-down
- Debt Reclassification
Modify that Mortgage
Under President Obama’s Homeowner Affordability and Stability Plan (effective March 4, 2009), homeowners with a first and second mortgage may be eligible for home mortgage modification. Eligibility will be determined if; 1) the amount due on the first mortgage is less than 105% of the value of the property, 2) on an agreement by the lender that the second mortgage will remain in effect, and 3) on your ability to meet the new payment terms of the first mortgage. The primary objective of this plan is to further reduce the monthly mortgage payments and make them affordable and sustainable for the life of the loan. The benefit is twofold; the lender will receive full payment on the loan under the new terms, and the homeowner will be able to remain in the home and continue to build long-term equity.
What is Chapter 13?
Also called the ‘wage earner’s plan,’ Chapter 13 bankruptcy often enables individuals with regular income to develop a plan to repay all or part of their debts. The plan typically runs between three and five years, but in no circumstances can it exceed five years.
One of the greatest benefits of filing bankruptcy under Chapter 13 is that the program offers the homeowner the ability to avoid foreclosure on a primary residence. Once Chapter 13 documents are filed, an automatic stay is entered with the court and notices are sent to all creditors. This automatic stay provides a temporary stop to all foreclosure proceedings as well as any other attempts to collect debts. The stay may provide both the homeowner and his or her attorney with the time necessary to prepare Chapter 13 documentation and develop a plan for repayment.
Another change included in the Homeowner Affordability and Stability Plan is a practice more commonly known as, ‘stripping down’ as part of a Chapter 13 bankruptcy proceeding. Previously strip down was allowed in bankruptcy of farms, investment properties and vacation properties, but not on the debtor’s primary residence. Under the new program, a bankruptcy court judge can determine homeowner qualification and then ‘strip off’ a second or even a third unsecured mortgage (unsecured meaning that there is no value in the physical property to cover the loan) on the home. This can occur if the value of the first mortgage is higher than the appraised value of the home. The court will require an independent assessment of the home and property as part of the evidentiary process. Once the Chapter 13 bankruptcy case has been completed with the courts, the second and sometimes even third mortgages will be written off and the homeowner will not have to repay the ‘stripped off’ debts.
What can you do?
Providing the proper information and documentation is critical to having a smooth filing process. If you’ve already contacted your lender and requested a loan review or modification, now is the time to gather all the necessary paperwork in order to process your application.
Included in the pertinent information for your lender’s consideration are:
- Monthly gross household income including recent pay stubs and documentation regarding any other income you receive.
- Most recent tax filing (2008 return)
- Information about any second or third mortgage on your primary residence
- Credit card payments including monthly balances
- Payments for any other type of loans held (including automobile, student, and lines of credit)
If you haven’t spoken with your lender or if all initial attempts at modification have failed, it may be time to talk with a bankruptcy attorney about next steps.
Debt Reclassification
Filing Chapter 13 provides the debtor with the ability to reclassify debt by order of whom to pay first in ascending order. The repayment plan is the most important part of filing for Chapter 13 as it outlines who, how much, and when each creditor will be repaid. Some debts must be repaid in full, these are known as ‘priority debts,’ as they are considered the most important debts you have and will be placed at the top of the list. Some priority debts include child support and alimony, wages you may owe to employees, and tax obligations (yes, Uncle Sam expects to be paid in full!).
After priority debts, your repayment plan will outline regular payments to be made on secured debts such as car loans and mortgage payments including any arrearages (past due payments).
Lastly, any remaining disposable income will be applied to unsecured debts including credit cards and medical bills. While these debts don’t necessarily need to be repaid in full, you do need to show that any disposable income is being directed toward these outstanding creditors.
Chapter 13 can also help homeowners who have substantial delinquent property taxes, water bills, and other liens. Once filed, notification of Chapter 13 can stop the town or county from foreclosure procedures and offer a debtor up to five years to repay the delinquencies.
The biggest take-away any debtor can have is that it is never a good idea to try to wait out the mounting phone calls and collection notices. Rather take control of your situation and talk with each creditor personally. In most situations, creditors are happy to work out repayment plans or make adjustments to your payment schedule. If after several attempts you are unable to reach an agreement or harassing collection calls escalate, it may be time to talk with an attorney specializing in consumer advocacy and bankruptcy.