Debt Limits in Chapter 13 Can Prevent the Stripping of Second Liens by Homeowners Filing Bankruptcy in Bay Area

Chapter 13 Debt Limits Prevent Some Bay Area Homeowners from Stripping LiensOf those who come into our offices seeking bankruptcy advice in the Bay Area, and who ultimately file for bankruptcy protection, around one third qualify for a Chapter 13 case, while around two thirds are best suited to Chapter 7 bankruptcy. Although it requires repayment of some portion of one’s debts over time, Chapter 13 bankruptcy allows the debtor to keep all of his assets and also offers a number of powerful tools that are unavailable in Chapter 7 bankruptcy such as the possibility of removing secured junior liens from one’s home or reducing the principal balance on a car loan in certain cases. However, Chapter 13 isn’t for everyone, and the Bankruptcy Code as well as a variety of practical considerations together determine who can feasibly qualify for Chapter 13 and who cannot.

Chapter 13 Bankruptcy is a repayment plan in which the debtor pays back a certain amount of his or her debt over a three or five year period. One important factor in determining whether one can qualify for Chapter 13 is the overall amount of one’s debts. In order to make the Chapter 13 repayment plan feasible, bankruptcy law requires that the Chapter 13 petitioner’s total debts cannot exceed certain maximum dollar amounts for both secured and unsecured debts in order to conform with the Bankruptcy Code.

The current Chapter 13 debt limits are $1,081,400 for secured debt, and $360,475 for unsecured debt. These limits were last adjusted April 1, 2010, and are adjusted every three years. The amounts are adjusted every three years to reflect the change in the Consumer Price Index for All Urban Consumers, published by the Department of Labor. The next scheduled adjustment will be in April 1, 2013. Bankruptcy Code §109(e) prohibits the use of Chapter 13 by individuals who exceed the specified debt limits. This means if you have secured debt obligations like mortgages or car loans that all together exceed $1,081,400, or unsecured debt obligations like credit cards, lawsuits, unsecured loans, or leases, that exceed $360,475, then you will not be able to take advantage of Chapter 13 Bankruptcy because you will not qualify.

Importantly, “lien stripping” or the removal of junior liens from real property in Chapter 13 can in certain cases actually cause a client to exceed these debt limits. This can be a real problem since lien stripping has in recent years become one of the most important tools in our Chapter 13 arsenal for providing debt relief to underwater homeowners in the Bay Area. As I have written about extensively in this blog and on our main bankruptcy site, in a Chapter 13 Bankruptcy, it may be possible for debtors to “strip off” their second mortgages and convert them from secured debts to unsecured debts. Once converted into unsecured debt, the Chapter 13 bankruptcy debtor may pay only a small percentage (or even zero percent in limited cases) toward that second loan (most often a home equity line of credit) while in Chapter 13, and then upon completing his payment plan, the debtor can emerge from bankruptcy owning the property free and clear of that second mortgage loan or equity line with any remaining balance discharged by the bankruptcy. Pretty powerful stuff.

The problem, however, is that lien stripping can sometimes actually cause Bay Area homeowners to go over the Chapter 13 debt limits. For example, suppose that you have a San Jose home with a first mortgage of $700,000, a second mortgage of $200,000, and credit card debt of $200,000. Even if you were successful in obtaining the Bankruptcy Court’s approval of your motion to avoid the second lien or “lien strip” motion, there would be a problem here with the debt limits. Prior to the motion being filed, there was secured debt of $900,000, and unsecured debt of $200,000, each of which are under the Chapter 13 debt limits. However, if this debtor were to file a lien strip motion and were successful, then there would be secured debt of $700,000, and unsecured debt of $400,000, which would have the disastrous effect of rendering the debtor now ineligible for Chapter 13 bankruptcy, and the case would then be dismissed by the Court!

There are many nuances to the Chapter 13 debt limits, and how they apply in various scenarios. Everyone’s situation is unique. It is therefore imperative that one get the advice of an experienced bankruptcy attorney. Call us for a free consultation.

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