You can surrender your underwater house in full satisfaction of the first and second mortgages in Chapter 13 bankruptcy

by Chip Parker, Esq.

November 15, 2010

Recently, Jonathan Ginsberg explained that second mortgage holders often pursue their unsecured claim after the first mortgage takes the house in foreclosure. In the wake of the largest meltdown of real estate in history, many homeowners are sitting on second mortgage time bombs.  Once the first mortgage company takes the property, the potential exposure to the second is tremendous – especially if it is securing investment property.

If the second mortgage lender chooses, it can sell the debt to a company that will harass or even sue the debtor, or it can choose to file a Form 1099(c) with the IRS which will create dollar-for-dollar income if the property is not the debtor’s home.

Many times, the best strategy for an underwater homeowner with assets to protect is to surrender the collateral (the house) in full and final satisfaction of the debt owed on the first and second mortgages in a Chapter 13 bankruptcy BEFORE the house is sold at foreclosure.

If a debtor files a Chapter 13 bankruptcy, he can propose a plan of reorganization which calls for the surrender of the house to the first AND second mortgage holders.  The second mortgage company cannot file a deficiency claim because the house has not been liquidated, and the parties will not know for sure that the second mortgage will have an unsecured portion.  Moreover, the actual liquidation of the house by the first mortgage company takes place far after the deadline for the second to claim that it got nothing from said liquidation.

The result is that a debtor wishing to protect assets or avoid a huge income tax liability can utilize Chapter 13 to bring a swift and satisfactory conclusion to an otherwise uncertain financial predicament.

This strategy works especially well for debtors who have little other debt because a 100% plan can be proposed that will pay 100% to all unsecured creditors.  Having a “100% plan” in Chapter 13 is like slipping the maître d’ $100 for the best table in the restaurant.  Everyone treats you like gold because you’re paying all creditors 100% – technically, even the 2nd mortgage by surrendering the real property in full satisfaction of the debt.

What’s that you say – you make $500,000 per year?  It doesn’t matter!  You have $1,000,000 in the bank?  It doesn’t matter! You want to pay off these creditors and get out of bankruptcy in just a few months instead of the normal 5 years?  Go right ahead! Not much else matters when you’re paying 100% of your unsecured debts.

Just because you surrendered the collateral doesn’t necessarily mean you must vacate the house.  You can still fight your foreclosure because when you surrender your collateral, you are surrendering to the “owner and holder” of the note and mortgage.  My bankruptcy judges have ruled that because Florida is a judicial foreclosure state, the alleged mortgage holder must pursue its foreclosure in state court before it can force the debtor from the real property.  However, since the homeowner has filed a bankruptcy, much of the downside risk involved in fighting the foreclosure is eliminated.    At best, the mortgage servicer can ONLY get the property.  It cannot collect any money from the homeowner.

I have filed more 100% plans in the last 12 months than in the previous 17 years of practicing bankruptcy law, and so far, my clients are very happy.  The key is finding a seasoned attorney capable of implementing a sophisticated bankruptcy strategy.

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Chip Parker is the managing partner of Parker & DuFresne, P.A., where he represents Northeast Florida businesses and consumers facing bankruptcy, and homeowners facing foreclosure. His firm files more homeowners in the Mortgage Modification Mediation Program than any other law firm in Northeast Florida. Parker is the recipient of Jacksonville Area Legal Aid's prestigious Award for Outstanding Pro Bono Service. Mr. Parker is an active member of the National Association of Consumer Bankruptcy Attorneys and National Association of Consumer Advocates.

Last modified: October 22, 2012