The Power of Chapter 13 to Save Your Home (and its Limitations)—Part 2

January 18, 2010 by Oliveros & O'Brien, P.C.

In last week’s blog we talked about the most basic ways that Chapter 13 helps you save your home: stopping a foreclosure with the “automatic stay,” curing the mortgage arrearage during the life of your case, and solving property tax problems.  This week we tell you about some of the more sophisticated tools that Chapter 13 may be able to provide for your home: 1) junior mortgage “strip-off,” 2) judgment lien “avoidance,” and 3) cure and release of income tax liens.

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1. Junior mortgage “strip-off”:

If you have a second or third mortgage, there is a chance that you will not have to pay it at all if you file a Chapter 13 case. That mortgage could be “stripped off” your home’s title permanently. This power to get rid of a mortgage that you voluntarily agreed to is highly unusual in bankruptcy. That’s because the law generally treats mortgages quite favorably, supposedly for the purpose of protecting the mortgage markets. (Now THAT hasn’t worked out so well these past couple of years, has it?!) But a “strip-off” is ONLY available in Chapter 13, NOT in Chapter 7. And it only works under this specific condition: your house must be worth LESS THEN the amount of the liens against the house “senior” to the mortgage being “stripped off.” In the simplest case, if there are no liens except a first and a second mortgage, then the house must be worth less than the first mortgage in order to “strip-off” the second. Here’s a little more sophisticated example:

$ 250,000     Value of Home

-   $7,000     Late Real Property Taxes

-$245,000     First Mortgage

($   1,000)    Negative Equity in Home for 2nd Mortgage

$   30,000     Second Mortgage

Because there is no equity in the home for the second mortgage, it can be stripped off.

Caution: We must file a special procedure in court in order to do this “strip-off.” The second mortgage holder may disagree about the value of your home or raise some other objection. If we do succeed in the motion, the court order stripping off the lien must then be recorded in the county records. Finally, you must successfully complete the Chapter 13 case or else the second mortgage lien reattaches to your home and you owe it in full.  We generally will require an appraisal of your home so the costs and fees are higher than an average chapter 13 case.  Having said that, the advantage of eliminating the entire debt on a second or third mortgage greatly outweighs the additional costs.

2. Judgment lien “avoidance”:

If before you file your Chapter 13 case a creditor files a lawsuit against you and gets a judgment, that judgment will attach to your home in the form of a judgment lien. That means that the judgment would have to be paid in full, usually with interest, whenever you sold or refinanced your home. Under the right circumstances, you can get rid of this judgment lien, as well as the debt behind it, through your Chapter 13 case. The judgment lien can be “avoided” if it affects the equity in your home that is protected by your “homestead exemption.” In Oregon, the “homestead exemption” is the amount of equity in your home which is protected from your unsecured creditors, in the amount of $40,000 for a single person, $50,000 for a couple. Here’s an example to illustrate how it works, assuming you are single, and you have a judgment against you for $15,000:

$    250,000     Value of Home

-   $220,000     First (& only) Mortgage

$      30,000     Equity in Home Before the Judgment Lien

$      40,000     Homestead Exemption

($    10,000)   Equity Beyond the Homestead Exemption

$             0    Amount of the $15,000 Judgment Lien that Can’t Be Avoided

Outside of bankruptcy, the $15,000 judgment would have to be paid and in some circumstances the judgment creditor would be able to foreclose on your house if you did not pay it. Inside bankruptcy, because the amount of equity in the home before the judgment lien ($30,000) is less than the homestead exemption ($40,000), all of that lien would be “avoided.”

Caution: As in the earlier case, “avoiding” a judgment lien takes a special procedure, one to which the affected creditor can object to by disagreeing about the value of the home or other pertinent issues, In the example, if the house would actually be worth $300,000, then the judgment lien could NOT be avoided because the equity In the house before the judgment lien would then be MORE than the $40,000 homestead exemption.

3. Income tax lien cure and release:

If you have fallen behind on your income taxes, the IRS or the Oregon Department of Revenue (ODR) may well have recorded a tax lien (called a “distraint warrant” by the ODR) against your home. Somewhat like a judgment lien, the IRS or ODR can foreclosure on your house through that tax lien or require it to be paid in full if you sell or refinance your home. But unlike a judgment lien, it cannot be “avoided” in the circumstances described above. It has to be paid, if there is equity in your home to cover that tax lien. If there is, then the tax related to that lien has to be paid in full or to the extent that there is equity to cover it. If there is no equity for the tax lien, then the tax related to that lien may or may not need to be paid depending on a series of factors. But in either case, Chapter 13 protects you from the IRS or ODR foreclosing or attempting to collect on the tax lien while you are in the Chapter 13 case. Then at the end of that case, the tax lien is released, having been paid to whatever extent required. You would no longer owe anything to the IRS or ODR and your home would be clear of any tax liens.

Caution: The intersection between tax and bankruptcy law is highly complicated, and has undergone some important changes in the last few years. Chapter 13 provides many advantages in dealing with income tax debts, but only if you have the help of someone who thoroughly understands these complicated rules. That means not just any bankruptcy attorney but one who is both highly experienced and keeps up on the latest developments.

Conclusion:

Chapter 13 is a more complicated way to deal with your debts than Chapter 7, but as you have seen it comes with some huge benefits when it comes to keeping your home. To set up a free consultation to learn about how these benefits would work for you and for your home, please click on the “Contact Us” tab above, or call Mike O’Brien at 503-786-3800. Mike is one of only three attorneys in ALL of Oregon who is Board Certified as a Consumer Bankruptcy Specialist by the American Board of Certification.