by Preston Gardner and James McGuire
The spike in real estate values has been a hopeful sign of an improving economy over the past year. For those considering bankruptcy, however, it should be viewed as a warning that certain bankruptcy rights could be lost in the near future. Specifically, rising home values may prevent you from removing or modifying second or third mortgages on real property through processes called “lien stripping” and “cramdown”—in which the value of the real property is always the starting place in the analysis. This means that increasing property values may provide you with only a limited window to file your bankruptcy.
In Chapter 13 and Chapter 11, “lien stripping” allows you to get rid of a second or third mortgage on your residence when you owe more on your first mortgage than the fair market value of your house. In such cases, your second mortgage is considered “wholly unsecured” and may be stripped through a Chapter 13 bankruptcy. The stripped liens then receive the same treatment as your other unsecured debts in your bankruptcy. These debts usually receive nothing or a small amount and get discharged at the completion of your Chapter 13 bankruptcy. After discharge, the lender with the stripped lien will be required to remove its lien from your house.
In addition, those with investment properties can take advantage of a “cramdown” in Chapter 11, which allows you to reduce the principal balance of a mortgage to the value of the property. If you own a rental property worth $150,000, for example, but your loan balance is $200,000, then you can cram down your loan to $150,000 (the value of the property) through your Chapter 11 plan. The remaining $50,000 of the balance would be included with your other unsecured debts.
For those whose first mortgage balance is close to the property’s current fair market value, a slight increase in property values can cut off the chance to get rid of the debt. Once the narrow window to strip off junior liens has closed, it may be a very long time before home prices increase enough for many homeowners to have equity in their properties. Consequently, these homeowners may end up paying on their junior liens for decades before home values exceed the secured loan balances.
If you have considered filing for bankruptcy to deal with issues related to real property, the best time to file your bankruptcy is now, not after the economy improves. With tens or even hundreds of thousands of dollars at stake, it makes sense to decide now whether you should file a Chapter 13 or Chapter 11 bankruptcy. Call 480.733.6800 and ask to meet with Preston Gardner or James McGuire in a confidential consultation to find out how to receive a fresh start and take advantage of the improving economy.