Bankruptcy Pay Down & Negative Equity Solution

On Behalf of | Jul 30, 2015 | Uncategorized

In a previous column, I wrote about an initiative that would allow the cram down of first mortgages on a debtor’s principal residence in a Chapter 13 bankruptcy.  The cram down was a proposal to cram down the amount of the principal balance due on a chapter 13 debtor’s primary residence to the current market value and treat that amount as a secured debt and the remaining balance would be treated as an unsecured debt in the chapter 13 bankruptcy.  Unsecured debts generally are only paid their pro rata share of the entire amount distributed to that class of creditors.  Generally unsecured creditors in chapter 13 bankruptcy are forced to take less than the total amount claimed.  The initiative failed to pass in both houses of the legislature.  Currently, the bankruptcy law does not provide for cramming down of a debtor’s first mortgage on their principal residence.  A debtor can, however, strip off a wholly unsecured equity line or junior mortgage to treat the balance as an unsecured through a Chapter 13 Bankruptcy Plan.There is some hope, however, on the horizon.  There is a new initiative that is being championed by the National Association of Consumer Bankruptcy Attorneys (NACBA) of which this writer is a member.  This new proposal is called the Principal Paydown Plan.  This plan is different than the previous cram down provision in that it does not require legislation if it is adopted by investors, insurers and government agencies.In a Chapter 13 bankruptcy, creditors can object or accept a debtor’s proposed Chapter 13 plan. The Chapter 13 plan that debtor’s propose is based on their disposable income available according to a means test.  This is a mathematical formula that takes income from all sources for a six month period prior to a potential bankruptcy filing date (not including the month of filing) and applies certain guideline standard deductions to determine the debtor’s disposable income amount available to pay back a portion of their creditors over the life of the chapter 13 plan.

The way that this Paydown Plan could side step the legislative process is by having these key stakeholders mandate the affirmative acceptance of Chapter 13 plans that contain a precise provision detailing and implementing the Paydown Plan. While there is still strong support for the bankruptcy mortgage cramdown, the Principal Paydown Plan can be used  as a tool in the absence of legislation to immediately affect a change in the negative equity problem that continues to plague many homeowners.

The Paydown Plan restructures certain under secured (when you owe more on your mortgage than the current fair market value of the property) mortgages in Chapter 13 bankruptcy cases so the homeowner can pay down the loan principal and reduce negative equity and build equity faster than with the existing loan.  This is accomplished by reducing the interest rate to 0% for five years (the maximum length of a Chapter 13 Bankruptcy Plan), letting the borrower/debtor’s entire monthly loan payment go directly to the principal.  During the five-year period, the minimum monthly housing payment is calculated similar to a HAMP modification payment which projects a payment calculated to be 31% of borrower’s gross income.

The Paydown Plan is scrutinized by the bankruptcy judge and the Chapter 13 Trustee reviews the debtor’s budget to confirm the eligibility of the borrower and feasibility of the payments; and they oversee the implementation of the Chapter 13 Bankruptcy Plan within which the Paydown Plan and the details would be made part thereof.  At the end of the five-year period, the remaining principal balance on the first mortgage is re-amortized as a 25 years at the Freddie Mac rate and monthly payment will adjust accordingly

There is no cram down provision in this current initiative currently so there is no need for legislation to amend the current Bankruptcy Code.  Moreover the benefit to the borrower is achieved by actually paying down the loan.  In exchange for this benefit, the borrower agrees to a general settlement of all claims against the lender and servicer and avoiding future title and loan litigation.  The federal government and US taxpayers’ substantial burden on Fannie Mae and Freddie Mac (all GSE) owned and insured loans would be reduced by this plan.

With many homeowners in this state underwater on their principal residence mortgages, the Principal Paydown Plan initiative could achieve principal reduction on certain mortgages. This plan if implemented and accepted, encourages underwater (when you owe more on your mortgage than the current fair market value of the property) homeowners to keep their homes and improves neighborhood stability without the necessity of an act of Congress.

 Cynthia A. Riddell is an attorney whose practice primarily focuses on Bankruptcy, Real Estate Foreclosure, Short Sales as well as other debt related matters.  She is a member of the Florida Bar and admitted to practice in the U.S. District Court for the Middle District of Florida.  She is a member of the National Association of Consumer Bankruptcy Attorneys and the American Bankruptcy Institute.  She practices in Sarasota and Manatee Counties.  Office phone number 941-366-1300.