What happens if you file a Chapter 13 case to save your home but a year or two later your income goes way down?
Our last blog post described what happens if a couple years into a Chapter 13 case circumstances change so that the debtors decide to sell their house instead of staying in it. In that situation they decided in the middle of their case to pursue a great opportunity to live elsewhere, convincing them to change their mind about their house. But they were nevertheless able to sell their house and move, and could still finish their Chapter 13 case while getting the rest of its benefits. Furthermore in that example they actually finished their case faster and did not pay their creditors any more than had they stayed in their house. So in that situation, the original decision to file a Chapter 13 case—made in part so that they could stay in their home—ended up still being a good decision even with their major shift in plans.
But what if the changed circumstance were not so positive? Would a decision to file a Chapter 13 case to save a house have been a bad decision if later in the case the house can’t be saved after all because of a significant loss of income?
Even Chapter 13 Has its Limits
Chapter 13 can be an extremely good way to save a home if it is under threat of foreclosure, but even this option has its limits. To hold onto a home through Chapter 13, you still need to meet a number of requirements. Among others, in virtually all circumstances you need to catch up on all your missed first mortgage payments by the end of your case. Even though that can give you as long as 5 years, it’s still money you need to make up—beyond keeping current on your regular monthly mortgage payment. If your income dips significantly, you may simply not have enough money coming in to accomplish this.
Our Example
We’ll look at how this can play out through a tangible example, using the married couple, Andrew and Amanda, who have been with us throughout this series. Briefly, they filed their Chapter 13 case to save their home from foreclosure and to deal with a substantial income tax debt. Their court-approved monthly plan payment is $525 per month, which they were originally scheduled to pay for four years, as well as paying their regular first mortgage monthly payment of $1,500. Most of what they were paying into their plan was going to catch up on their mortgage arrears and to pay income taxes that they could not have discharged (legally written off) in a straight Chapter 7 bankruptcy case.
Now two years into their case, Amanda was in a major car accident in which she was seriously injured. The other driver sustained only minor injuries. The accident appears to have been caused mostly by Amanda’s negligence. Her medical bills fortunately are all being covered between her vehicle insurance and her medical insurance. But she has no coverage for loss of income. Amanda has just learned that her doctors are predicting a long rehabilitation process resulting in her being unable to work for at least a year, likely closer to two years, maybe more. She has started receiving some income from disability insurance but it is about $700 less per month than what her work income had been.
Tough Choices
Amanda and Andrew are wondering if her loss of income for such a long span of time means that they now need to or ought to give up their house.
As far as their Chapter 13 plan calculations if they still wanted to keep their house, the problem is that there is too much that absolutely must be paid during the remaining 3 years of their plan and not enough money each month to do it.
Under the terms of their court-approved Chapter 13 plan, $325 of the $525 monthly plan payment was going towards the house arrears. So now two years into their case that still leaves them more than $7,000 in arrears out of the original $15,000. Plus they owed $5,000 in recent income taxes that had to be paid before the end of their case, of which $1,500 was paid during the first two years of the case, leaving $3,500 to be paid. That’s $7,000 in mortgage arrears plus $3,500 in taxes to go, or $10,500, plus an estimated $400 in additional attorney fees, plus about $1,090 (10%) to the Chapter 13 trustee, for a total of about $11,990 more to be paid through their plan. Their original 4-year plan could be stretched to 5 years, giving them 36 months more months to pay this $11,000, or about $335 per month.
But with $700 less monthly income, Andrew and Amanda have NO money available to pay into their Chapter 13 plan.
In any event, their house has a lot of stairs, not good because of Amanda’s injuries. So all of a sudden the place they used to love is not looking so great. They’ve looked at rentals and have found a suitable single-level place for about $1,200 in monthly rent, saving $300 off their $1,500 monthly first mortgage payment.
A Good Option
When Andrew and Amanda talk to their attorney they learn that if they give up their house, they could afford to finish a pared down version of their Chapter 13 case and still get most of its originally-intended benefits.
Without the house, they would likely need to pay only the $3,500 unpaid recent income taxes, about $400 in additional attorney fees plus about $390 in trustee fees, and, or a total of about $4,290.
Before Amanda’s accident the couple had been paying a $1,500 monthly first mortgage payment plus $525 monthly plan payment, or a total of $2,025 for those two items. With $700 less income available, the couple now has $2,025 minus $700, or $1,325 available for housing plus the plan payment. With the rental at $1,200, that leaves $125 available for the plan payment.
So Amanda and Andrew decide to surrender their house to their first mortgage lender, and reduce their Chapter 13 plan payment to $125 per month. That would finish their case in about 34 additional months. At the end of their case they will have paid off the income taxes, and legally discharged any and all of their other obligations, including any related to their house, leaving them debt-free.
Lessons Learned
When Andrew and Amanda decided to try to keep their house by filing a Chapter 13 case two years earlier, was that a good or bad decision in light of what ended up happening?
Had they been able to know the future, they may well not have tried to save their house. After all, they paid about $325 extra each month beyond their regular mortgage payment for two years in an eventually fruitless effort to catch up on their mortgage.
But they didn’t know the future. Chapter 13 gave them a mechanism through which to catch up on their mortgage, pay their recent income taxes and discharge (write off) their older income taxes, strip their second mortgage, discharge a lot of credit cards and other debts, AND keep all these creditors at bay throughout this time. (See the recent blog posts in this series for more about these.) When their circumstances changed greatly, some of Amanda and Andrew’s prior efforts did not come to fruition—as to the house. But Chapter 13 gave them the opportunity to save their house, and they were well on their way to successfully doing so, when an unforeseeable event derailed their best-laid plans.
Nevertheless, Andrew and Amanda were able to adjust their Chapter 13 case to address those changed circumstances. Chapter 13 had enough flexibility so that they were still able to meet the other goals of their Chapter 13 case, and to do so without additional hardship. So, their initial decision to file a Chapter 13 case was a sensible one, even if life turned in a different direction than they had anticipated.