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Chapter 13 – A Viable Loan Modification for Your Second Residence

Tuesday, May 11th, 2010

Another Installment of “Ask Doan Law Firm

Q: I was reading in the newspaper that when you file for a chapter 13, you can also request to modify your 1st mortgage to the current value of the house.  Is this correct?

A: The bankruptcy code specifically prohibits modification of a mortgage on a primary residence.  A mortgage on a secondary residence may be modified. The way the modification works is that the court may “cram-down” the principal amount of a mortgage on a property to its market value.  However, the court’s ability to do this only lasts for the duration of the bankruptcy so the entire market value of the home must be paid during the course of the bankruptcy so that the court may “finalize” the loan modification before the bankruptcy ends. It is based on the same code provisions that allow a bankruptcy court to determine that secondary (and tertiary, etc) trust deeds on a property are completely unsecured by any residual value in a property after considering the first trust deed (primary mortgage) and current fair market value, which results in the court’s ability to grant the lien strips.

Thus, if the “non-primary residence” property has a market value of $200K, then you must pay $200K in the course of about 3-5 years (i.e. about $3,667 per month) in addition to any other amounts required by your bankruptcy plan. In addition, depending on your county, the Trustee may decide not to let this come at the expense of your unsecured creditors… therefore it effectively cannot be your own money that pays this monthly amount (you will need a renter) or you will also need to pay off an equivalent amount of your unsecured creditors.

Practically speaking, cramdowns on mortgages only occur when the property value is very low.

Previously, the bankruptcy court did have the power to modify mortgages on primary residences. Congress explicitly removed this power and as of the last Bankruptcy Code revision has not reinstated it. There was legislation last year regarding reinstating this power of the court, but it was contained in a broader bill rejected by the US Senate.  Currently to the best of my knowledge the legislation has not been reintroduced.

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