17 May Reducing First Mortgages in Chapter 13
With the declining real estate market, its becoming more and more common to “lien strip” wholly unsecured second mortgages/deeds of trust on personal residences. The general rule is that these second, third, and later liens can all be removed off the residence provided the first mortgage/deed of trust is also partially unsecured, or secured in full to such an extent that the next lien has no security in the property whatsoever due to the decreased fair market value. But what about real estate with only a first mortgage/deed of trust and no other liens. Can that be reduced too in Chapter 13? Sometimes.
As long as the property is not your personal residence, a chapter 13 can operate to split that mortgage/deed of trust into a secured component for the present fair market value, and unsecured component for the remainder. For example:
You purchased investment property during the real estate frenzy, it was never your personal residence, and you never lived there. The purchase price was $500,000.00 but now its only worth $250,000.00. At first blush, you may want to “walk away.” But what if you could reduce that lien to $250,000.00, refinance it for that amount, and have the current rent cover the new reduced mortgage payments? If you could keep the property and have the cash flow wash, or even be positive, would you? I hope so! But there are two important caveats.
First, lien modification can only take place on real estate that is not the your principal residence. So you cant do this on property you live in or purchased as your personal residence. Second, the lien must be paid in full over the life of the plan(3 to 5 years). While this sounds scary at first, a simple refinance a couple years into the plan will resolve this.
For you doubting Thomas’s, the following cite comes from a 2004 ninth circuit court decision(Enewally v. Wash. Mut. Bank (In re Enewally), 368 F.3d 1165) on this very issue, and also cites to the US Supreme Court.
The Supreme Court has spoken directly in Dewsnup and Nobelman. Dewsnup cautioned against courts fashioning a “broad new remedy” under § 506(a) where the remedy was not “mentioned somewhere in the Code itself or in the annals of Congress.” 502 U.S. at 420. In Nobelman, the Supreme Court explained that, in a Chapter 13 plan, stripping down an undersecured lien to the value of the underlying collateral pursuant to § 506(a) valuation, “would require a modification of the rights of the holder of the security interest” pursuant to § 1322(b)(2). 508 U.S. at 332. In order to hold that the debtor’s lien stripping proposal is viable under the “cure and maintain” provision of § 1322(b)(5), we would have to hold that § 506(a) coupled with § 1322(b)(5) provides a new remedy allowing modification of secured debts in Chapter 13 independent of § 1322(b)(2). The logic of Dewsnup and Nobelman do not permit this construction. As both the district court and bankruptcy court noted, lien stripping on debts secured by real property that is not the debtor’s primary residence is permissible in Chapter 13, even after Nobelman. However, it must be accomplished in a manner consistent with § 1322(b)(2). Because § 1322(b)(2) does not allow a modified secured debt to be paid over a period of time longer than the plan term, the debtors’ proposed plan modification must be disallowed.
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