In my experience the number one reason people choose to file Chapter 13 instead of Chapter 7 is to save their home. And it’s not just because it gives you a bigger hammer against your mortgage company. It gives you a hammer, but also a whole bunch of other tools. Some are more subtle but just as important in the right case. Each person’s situation probably doesn’t call for more than a few of those tools, but it’s great to have them all in the tool chest. So let’s look at the ten main ones, the first five in this blog and the other five in my next one.
1. The one tool most people know about is that in most circumstances you are given the length of your Chapter 13 Plan–as long as 5 years—to cure your mortgage arrears, the amount you are behind on your mortgages at the time your case is filed. Outside of Chapter 13, mortgage companies seldom let you have more than a few months to pay the arrears, an impossible task if you are not expecting to receive some windfall of money. During the entire repayment time that a Chapter 13 allows, you are protected from foreclosure and most other collection efforts, just so long as you play by the rules laid out in your Plan. If you do play by those rules, you will be completely current on your home when you finish your case.
2. A benefit of Chapter 13 which has become tremendously helpful during these last few years of shrinking home values is the “stripping” of junior mortgages. If your home is worth no more than the amount of your first mortgage, then any second mortgage can be “stripped” of its lien against your home and treated in your Chapter 13 case like a “general unsecured creditor.” That means that the second mortgage balance is lumped in with the rest of those bottom-of-the-barrel creditors, and whatever portion of the balance is not paid during your case is written off at the end of it. This is not available in Chapter 7.
3. Both Chapter 7 and Chapter 13 prevent federal and other income tax liens from attaching to your home, but, assuming the lien would be on a tax that cannot be written off in bankruptcy, Chapter 7’s protection lasts only a few months. The tax lien can be imposed against your home just as soon as the Chapter 7 case is over, usually only about three months later. This gives the IRS or other taxing authority lots of additional leverage against you, requiring you to pay lots more interest and penalties, AND putting your house in jeopardy. In contrast, if you file a Chapter 13 case before a tax lien is recorded, there will never be a tax lien against your home. That’s because this tax will be paid off in your Chapter 13 case as a “priority creditor,” without any additional interest or penalties, with no tax enforcement—including a tax lien recording—permitted throughout the process.
4. Chapter 13 is also the better route if your home already has an unpaid income tax lien against it before you file bankruptcy. Again assuming that lien was imposed for a tax that cannot be written off in bankruptcy, Chapter 7 case neither provides you a way to pay this tax nor protects you from the full force of tax collection for any longer than a few short months. In contrast, Chapter 13 both provides you a mechanism to pay these inescapable debts on a reasonable timetable and protects you while you do so.
5. A key point of Chapter 13 is that it slashes your other debt obligations so that you can gain the needed monthly cash flow to better be able to afford your necessary home obligations. Amazingly, in many cases you can have more room in your budget to pay towards your home even than if you had filed a Chapter 7 case. That’s because if you owe certain kinds of debts that would not be written off in a Chapter 7 case—such as an ongoing vehicle loan, certain taxes, child or spousal support arrears, and most student loans—Chapter 13 could well allow you to pay less each month on those obligations, leaving more for the home.