Chapter 13 Bankruptcy or Mortgage Modification What is My Best Option?

            In a perfect world every delinquent homeowner borrower would receive a timely mortgage modification from their lender which neatly fits their current financial situation to save their home. Unfortunately many homeowners who have applied for mortgage modifications have found out that the process moves incredibly slowly especially with the major lenders with the most delinquent loans. Furthermore, when and if a mortgage modification is finally offered it does not offer the relief needed for them to keep their home for the long term. One of the problems is the size of the mortgage arrearage that has accrued during the drawn out mortgage modification process. With government programs like HAMP that  generally do not provide mortgage principal balance reduction the size of these arrearages can offset the effect of  the interest rate deduction and extension of maturity date on the new monthly mortgage payment being offered to homeowners. The problem is when the mortgage arrearage is added to the current principal balance this increase in the principal balance negates the potential reduction offered by the lowered interest rate and extended maturity date. The net result is the borrower being offered a new loan with a principal balance well in excess of the current value of their home with a slightly reduced new mortgage payment. This type of modified loan does not offer any real true benefit to a delinquent homeowner borrower. Therefore, before starting the mortgage modification process with a lender a borrower needs to find out the potential modification programs available for their loan and approval timelines if at all possible. The borrower than should next consult with a bankruptcy attorney to  determine if a Chapter 13 filing is a better option for them than pursuing what may turn out to be a dead end modification.

          The best candidate for a Chapter 13 is a debtor who has suffered a temporary income setback that caused their default, but has now returned to work and said default was not directly attributable to the terms of loan itself. That is it was not an 80/20 high interest loan combination, but instead a loan with a reasonable fixed rate of interest with a monthly payment that now that the borrower is working again is a reasonable amount to pay. The borrower must also have the current ability to pay the extra monthly amount required into a Chapter 13 plan to at least bring the mortgage arrearage current upon completion of the plan. This is an extremely important point. If a borrower does not have sufficient income to fund a plan than a mortgage modification with the necessary lowering of the mortgage payment, if attainable, is the only real option they can pursue to save their home.  However, a borrower who has the current ability to fund a Chapter 13 plan needs to make an important decision. Do they risk applying for a mortgage modification only to be rejected or offered an unacceptable modification and forgo their opportunity to file a Chapter 13 later due to the increase in the mortgage arrearage making it not feasible for them to fund a Chapter 13 plan.  Realistically I have not seen delinquent homeowner borrowers demonstrate the ability to set aside the necessary monthly mortgage payments while applying for a modification to offset the increase in the mortgage arrearage to keep their ability to file Chapter 13 viable. This decision of Chapter 13 versus mortgage modification needs to be made with the advice of bankruptcy counsel who can review the debtor's financials and provide them with a realistic opinion as to the feasibility and success of filing a Chapter 13. The advantage of a Chapter 13 bankruptcy versus a mortgage modification is that the only real party in interest you have to satisfy is the Chapter 13 trustee and the debtor is not subject to the whims of the mortgage lender. If the debtor has sufficient income to support their plan as determined by debtor's counsel and provided to the Chapter 13 trustee the plan will be confirmed. Additional benefits of a Chapter 13 include the possibility of discharging some or all of a debtor's unsecured debt dependent on their assets and income. If a plan is going to include the discharge of unsecured debt wholly unsecured second mortgages can be deemed unsecured by the plan as well judgment liens which impair a debtor's homestead exemption. I have written this blog article based on my experience with debtors over the past several years since the mortgage crisis first started who after one or more years of unsuccessful attempts to obtain a mortgage modification contacted me regarding Chapter 13 as an option only to be told it was no longer feasible due to the amount of their mortgage arrearage. It is my hope that any borrower who is not too delinquent and is weighing their options will consult with a bankruptcy attorney first before blindly applying for a mortgage modification so they can make an informed decision what option best fits their situation.

What Should I file Chapter 7 or Chapter 13 Bankruptcy?

               An initial question that needs to be addressed when a consumer debtor wants to file bankruptcy is what Chapter they should file under. In practically all consumer cases Chapter 7 or Chapter 13 are the two options that may be available. Chapter 7 is usually the preferred alternative for debtors with significant unsecured debt. In Connecticut qualified debtors can file a Chapter 7 bankruptcy and have their discharge entered within sixty days of the 341 creditors meeting. This usually results in a discharge being entered less than four months from the date of filing. From that point forward the debtor’s credit will start to improve as long as they do not incur delinquent debt going forward. In most consumer cases debtors can retain their property in a Chapter 7 including even homeowners’ current with their mortgage payments by applying the appropriate exemption to said property.

Chapter 13 is a payment plan bankruptcy that is most commonly used by homeowners to save their homes from foreclosure. Homeowners who have had a disruption in their income or medical crisis causing them to default on their mortgage can file a three to five year payment plan to catch up on their mortgage and stop the loss of their home by foreclosure if they have sufficient income to fund a plan. Depending on the amount of non-exempt assets, if any, and the debtors' income and expenses a debtor may be required to pay from zero to one hundred percent of their unsecured creditors under their plan. For debtors with high unsecured debt who do not qualify for Chapter 7 due to the means test or possible asset issues Chapter 13 may be their only bankruptcy option. In their Chapter 13 they will usually be required to pay some or all of their unsecured debts over a five year period and the discharge of any debt is delayed until the completion of their plan. The Chapter 13 trustee’s goal is to maximize the recovery for creditors so the monthly plan payments may stretch the debtor’s budget thin for that five year period and it may require some belt tightening for the successful completion of their plan. Chapter 13 involves more work than a Chapter 7 and consequently the legal fees are higher. This does not mean Chapter 13 is not a good option for debtors. As indicated above it clearly serves the homeowners best who have suffered an interruption in their income and fallen behind on their mortgages allowing them stop foreclosure and catch up. For those with unsecured debt who do not qualify for Chapter 7 a Chapter 13 does provide an ordered plan to pay back this debt while stopping the accumulation of high penalty interest and late charges with the benefit of the bankruptcy stay preventing and stopping any collection litigation and any post judgment wage garnishments and bank executions. Any debt not paid through the plan is discharged including debts from unsecured creditors who fail to file proofs of claim by the court appointed deadline.  The key difference in the two Chapters is that Chapter 7 debtors’ fresh start will begin approximately four months from their filing date while Chapter 13 debtors are looking at a minimum of three years of plan payments before they can put their financial problems behind them.

                                         

Bankruptcy Allows You to Keep Your 401k and IRAs so Don't Liquidate to Pay Your Creditors

   The conversion of a 401k or ira to pay creditors can be avoided by filing Chapter 7 Bankruptcy. These types of retirement accounts are exempt assets and can be kept for their  future intended usage as retirement income. It is a mistake to convert an exempt asset like a 401k into a non-exempt asset by taking a 401k advance and deposit it into a personal bank account. The fact the funds can be traced back to the exempt 401k does not change the fact that they are no longer exempt. This mistake can be compounded by paying creditors with it if you could instead qualify for a discharge of your debts under Chapter 7 Bankruptcy. Also even if you do not pay creditors with these funds what may appear to be a logical decision to deposit these funds into a relative's bank account to avoid any bank executions from outstanding judgments is a problem since the asset is now now longer exempt and has been transferred to an insider which under the Bankruptcy Code the Chapter 7 trustees can treat as an avoidable transfer for two years prior to the bankruptcy filing. Even if these funds have been paid back to the debtor prior to filing that does not cure the fraudulent conveyance under the terms of the Code and the relative who was doing the debtor a favor is subject to suit by a bankruptcy trustee for the amount transferred.  Whenever faced with overwhelming debts before you liquidate your retirement accounts you should consult with a bankruptcy attorney to review your options to see if you can keep these accounts and discharge the debts with a bankruptcy filing.

Tax Exemption for Mortgage Debt Relief is Extended for 2017

   2017 Update-

"On February 9, 2018 the President signed into law a one-year extension of the exclusion. The retroactive extension was buried in the 652 page Bipartisan Budget Act of 2018, Public Law No. 115-123 § 40201....The Act revives the exclusion from taxable income for qualifying principal residence indebtedness discharged before January 1, 2018 and to written discharge agreements executed before January 1, 2018. This will enable individual taxpayers to claim the exclusion for returns they file for their 2017 calendar year income. Given that Congress has rejected prior attempts to make the exclusion permanent, the likelihood of future extensions is doubtful." see full article @ https://library.nclc.org/last-minute-relief-foreclosed-and-struggling-homeowners-now-filing-their-taxes 

  Update for 2014-As of January 1, 2014 the tax relief act was not extended. There is a bill sponsored by two CT congressman to extend pending, but with our gridlocked Congress no guarantee that any extension is forthcoming. There is still a way for many sellers with pending short sales or in need of short sales to avoid negative tax consequences in 2014. If the seller is insolvent at time of sale the forgiven debt will not be considered as income if their liabilities exceed their assets in an amount equal to or in excess of the forgiven amount. IRS Publication 4681 provides examples of the application of this exception and a worksheet to calculate personal assets and liabilities to use for individuals tax returns. Although unusual some bankrupt homeowners seek to short sell after receiving a bankruptcy discharge. In these situations the mortgage debt  discharged by the bankruptcy does not constitute taxable income and there is no debt cancelled by the bank's acceptance of a short sale just the release of the mortgage securing the home.

      In 2007 to avoid hitting distressed homeowners with the double whammy of foreclosure and tax debt from uncollected foreclosure deficiencies The Mortgage Forgiveness Debt Relief Act was enacted. This Act is set to expire on December 31, 2012 and based on the current political climate in Congress things do not look good for the extension of this Act. This Act applies not only to foreclosure deficiencies forgiven, but to short sales, deeds in lieu of foreclosure and mortgage modifications with principal forgiveness.  It has allowed underwater financially strapped homeowners to take advantage of government and lender mortgage relief efforts without the consequence of receiving a 1099 with phantom income and related high tax liability. Short sales have become an attractive option for many homeowners and lenders since the homeowner is relieved of the underwater property and mortgage debt and the lender receives an acceptable payment from the sale without having to incur the costs and delays involved with the foreclosure, maintenance and sale of the property. Short sales have also been fueled by the National Mortgage Settlement stemming from the litigation brought by the State Attorney Generals against mortgage lenders. This Settlement has also spawned mortgage modifications with actual principal forgiveness which I have personally seen increase this year. Before this settlement act my clients that received debt forgiveness were in contested foreclosure cases that I had filed special defenses and counterclaims. The impact of the loss of the tax forgiveness in 2012 will take the teeth out of this settlement leaving distressed homeowners without the relief it was intended to provide them. They will not benefit from a short sale or mortgage modification with forgiven debt if they are faced with a large tax liability.  Unfortunately these tax liabilities will be large since many of these mortgages have been in default for years combined with properties that are significantly underwater so phantom income in excess of $100,000.00 or more will not be an unusual consequence. Also since the IRS is provided with such extraordinary collection powers and income tax debt is treated as a priority debt in bankruptcy there is no debt more frightening to any U.S. citizen than delinquent income tax debt.

What the loss of this tax relief will mean is that more distressed homeowners who cannot afford their underwater homes will simply walk away from them. Homeowners who would have originally viewed a mortgage modification with principal forgiveness as a godsend will not accept these offers due to the accompanying tax burden. These facts will in turn lead to more foreclosures and more borrowers may have to file bankruptcy to discharge foreclosure deficiencies that could have been avoided with the Act in place with a short sale or mortgage modification. Another sad consequence is that for distressed homeowners who really want to hold onto there homes they may be forced to accept a mortgage modification with no debt forgiveness despite being eligible for it just to avoid the negative tax consequences. This would negate the intended benefit of the attorney general’s settlement act and provide an unintended benefit to lenders. There is little more than a month for Congress to act and there are even larger issues being debated in Washington that overshadow the need to extend this mortgage debt relief act. One can only hope that as the year closes the vital need for the extension of this act is recognized for the sake of not only distressed homeowners, but for the entire housing market since the negative effects of increased foreclosures will continue to drag the U.S. economy down into 2013 and beyond.
UPDATE: THIS TAX EXEMPTION WAS EXTENDED TILL JANUARY 1, 2015 WHICH IS PROJECTED TO BE THE LAST EXTENSION DUE TO POLITICAL REASONS.

When is The Appropriate Time to File Chapter 7 Bankruptcy? Part 2 Income Issues

       Although income considerations were always a factor in determining when and if to file a Chapter 7 bankruptcy the creation of the Mean Test by the amendments to the Bankruptcy Code in 2005 added more to consider in making this decision. In simple terms the Chapter 7 means test uses the IRS median income based on household size and applicable state to first determine if a debtor has to satisfy the means test in order to qualify for Chapter 7. For example for a three person family in Connecticut the current median income is $82,797.00. If the debtors' combined income for the six-month period immediately preceding a bankruptcy filing calculated on an annual basis equals less than the $82,797.00 there is no “presumption of abuse" and no need to complete the means test. If the opposite is true than the means test needs to be completed which makes the filing more difficult due to the arbitrary means test expense calculations and the strong likelihood of a United States trustee audit of the file to determine eligibility for discharge. This means in cases where debtors' incomes are close to the median income and fluctuate from month to month the timing of the filing can determine whether the means test comes into play or not.  Clearly all other factors aside the appropriate time to file is when the six month income brings the debtor below the median income to avoid the means test. This by itself will not determine whether debtors may file Chapter 7.  There are still the income and expenses schedules that need to be completed for which the income and monthly expenses for the next 12 months are projected. These schedules are based on actual figures and allow debtors to take into account recurring expenses like student loans which the means test does not.  I find that in most cases if a debtor has reached their financial bottom and reached out to me to help them that if their income falls below the means test median income they usually qualify for a Chapter 7 discharge. 

     Another factor to look at when reviewing income and the means test is the household size of the debtors. The definition of household size is not necessarily just the nuclear family. If an elderly relative or sibling with little or no income contribution to the debtors' household income lives with the debtors' family for the six month period prior to filing they can be included in household size. In some cases this increase in household size can make the difference whether the debtors have to pass the means test or not.  Finally, if it turns out that the debtors have to pass the means test it does not mean they automatically will not qualify for a Chapter 7 bankruptcy. Each case is unique and in cases where the debtors have large secured debts due to mortgages and car loans and they intend to keep these assets there is a stronger likelihood that they will pass the means test. This may also be the case where a debtor has high recurring medical costs due to a medical condition which can be viewed as a special circumstance under the means test. I had a case like this and after providing the necessary doctor reports and proof of medical expenses to the US Trustee my client obtained her discharge. These audits are not easy, but if debtors can provide the requisite documents to the US trustee to satisfy their audit they can obtain a discharge.

No Shame If You Need to File Bankruptcy to Obtain a Fresh Start

The emotional reaction that my clients have toward filing bankruptcy is always an important consideration that I take into account during my initial consultations with them. There are very few clients that I have met with that do not possess some degree of shame or sadness due to the fact they have reached their financial bottom and need to file bankruptcy. Certainly back in 2005 when creditors were able to have the bankruptcy code rewritten in their favor there was a concentrated publicity campaign to depict all bankruptcy filers as gaming the system. The language added to the code included terms like "presumption of abuse" and "abusive filing." This initially created the mistaken belief that bankruptcy was no longer an option for most people suffering financial difficulties. A result that the creditors behind the changes to the Code were no doubt quite pleased with. Over time this misplaced belief has dissipated, however, I still see that my clients are affected by the stigma that creditors wanted to attach to bankruptcy filers. I am not advocating that anyone take a cavalier and irresponsible attitude toward their debt obligations by filing bankruptcy. My point is that if someone without the income and assets needed to pay off their debts has reached their financial bottom there is no shame obtaining a fresh start by filing bankruptcy. Understandably it may not be the option all people want to take and it is not a decision to be made lightly without proper advice and counsel. During my consultations I not only have to address the legal issues that may be involved, but help counsel clients with the emotional baggage that has built up over time and cannot be overlooked at these meetings. They made need to vent or cry and that is okay since it is all part of working through their emotions. My holistic view of a fresh start is that it is not only a financial one, but an emotional one that allows clients to move forward positively to rebuild their lives.

When is the Appropriate Time to File Chapter 7 Bankruptcy? Part One:Preferential Transfers

    After the initial determination that a Chapter 7 bankruptcy is the best option for a client one of the next issues that needs to addressed is when should they file? There are a number of factors that determine the appropriate time to file some of which can have significant consequences if not handled properly. The discussion below focuses on the effect of preferential transfers and the appropriate time to file bankruptcy. First, assuming there are no other reasons to hold off filing the existence of a judgment with wage and bank executions makes filing as soon as possible necessary to avoid and decrease any future losses. This need to file right away may be countered, however, with the existence of a preferential transfer which may mean the client needs to delay their filing till the relevant preference period expires. If a loan is repaid to an insider relative within one year of a bankruptcy filing this automatically is considered an avoidable transfer by the bankruptcy code. What this means is that the bankruptcy trustee can go after poor mom and dad for the money that was repaid to them and disburse that to the debtor's creditors. Certainly not a result any client wants his parents or siblings to have to go through as a consequence of their bankruptcy filing. The remedy of course is to wait till the year has expired before filing bankruptcy. Also it is important that the payment back to mom and dad was a valid repayment of a loan and not a fraudulent conveyance to hide assets from creditors. I will leave the discussion of fraudulent conveyances for another post, but suffice it to say that the look back period is at least 4 years for these types of transfers and even then depending on what, when and how much was transferred bankruptcy may never be an option.   

During the pre-filing ninety day preference period any payment in excess of $600 to any creditor of an antecedent debt can be avoided by the trustee. An antecedent debt, for example, is an old credit card bill or medical bill as opposed to a monthly mortgage, utility or car payment. Now in many cases unlike a transfer to an insider relative a client may not care if a trustee were to go after Bank of America to get back a $1,000 preferential credit card payment and still file within the ninety days. This may and usually is not the case when the payment is to the family dentist for some recent dental work who the client wishes to remain on good terms with. Again the remedy is very simple just wait for the 90 days to expire to file bankruptcy and Doctor Goodteeth will not hear from the trustee and will continue to treat the family. This post only touches upon the timing of a bankruptcy filing in relation to possible preferential transfers and there are several other factors including asset issues, foreclosure and/or loan modification status and income fluctuations among others that need to be considered before filing bankruptcy. I will address these issues in future posts so stay tuned for Part Two.