Chapter 13 is known as the “personal reorganization” bankruptcy, otherwise known as the “pay what you can afford” bankruptcy. You definitely do not lose anything here and another great feature is that you can dismiss your case at any time.

Chapter 13 Bankruptcy Example 1

Mr. and Mrs. Jones own a nice home, drives a BMW 5 series sedan and a Suburban. Mr. Jones owns a once very successful construction business. But during the last couple years, he has seen a dramatic downfall in the amount of work. This is actually an understatement because business has literally dried up. He is starting to see a small trickle, but rather than suffer through the ups and downs of owning his own business, has decided to take a job with a much bigger construction firm as a construction foreman. Mrs. Jones managed to get a part-time job as a substitute teacher.

They have fallen behind about 12 months on their first mortgage and second mortgage. They tried getting a loan modification through one of those outfits that advertised on the radio, but was unable to get one. They tried it on their own and managed to get a 6 month trial period modification. Now they are facing a foreclosure auction date that is just a week away.

They have racked up $100,000 in credit card debt and have used all of the $150,000 line of credit on their home. Their home is worth less than the $400,000 mortgage. A classic case of the home that is “under-water” or “negative equity”.

Their main goal is to stay in this home because they have rooted themselves so deeply in this community that they refuse to leave. The children were born in this home and they plan to raise their kids here until they go off to college.

The First Mortgage:

A Chapter 13 bankruptcy filing would allow the Jones 3-5 years to catch up on their mortgage defaults instead of paying it all at once.

The Second Mortgage/Home Equity Line of Credit:

Because the home is worth less than the amount of the first mortgage, the second mortgage is considered “unsecured”.  A Chapter 13 plan can provide that this second mortgage be treated as a truly unsecured debt. But what’s the difference between secured and unsecured and why is that important in a Chapter 13 bankruptcy?

Secured vs. Unsecured Debts:

Secured debts are ones in which you offered up (knowingly or unknowingly) some sort of collateral to secure the loan. Home loans are secured. So are auto loans. Many department store credit cards are secured. This distinction is important because secured debts have to be paid (especially on a primary home mortgage) if you want to keep the house. Unsecured debts do not have to be paid 100%. They can “pay what they can afford to pay”. Hence the name.

Length of a Chapter 13 Bankruptcy

Normally, the debtors have 3-5 years to complete their plan. In this case, if the income requirements permit, the Jones may want to choose the 5 year plan because it spreads out the mortgage defaults over a longer period and makes it more affordable.

The Result:

Quite possibly, the result after a 5 year plan of debt consolidation could be that all credit cards and the second mortgage could be wiped out, while they keep their home with only a first mortgage remaining.

Misconceptions about Chapter 13 Bankruptcy

Misconception #1: When people hear about how the second mortgage can be removed or eliminated, they immediately jump to the conclusion that somehow the first mortgage can be modified. Might be true for a second home, vacation home, or investment home, but not your primary residence. The same people have heard that all second mortgages can be eliminated, but don’t realize that the value of the home has to be below the total amount due on the first mortgage. This is where an experienced Chapter 13 bankruptcy lawyer will be useful to the Jones.

Truth #1: Only second mortgages on a primary residence where the value is less than the total of the first mortgage can be modified in the above manner.

Misconception #2: I can file a bankruptcy just to stop the foreclosure and there will be no consequences.

Truth #2: There are always consequences for certain actions, and this is no different. Without carefully tailoring your Chapter 13 (and any future bankruptcy filings), you might not be able to re-file another bankruptcy for 180 days or enjoy the protections of a second Chapter 13 filing unless some stringent requirements are met.

Want to know more or whether you are a good candidate for a Chapter 13 bankruptcy in Los Angeles?

Feel free to call us to speak with a Los Angeles bankruptcy attorney.