Choosing Between Filing Chapter 7 and 13–Easy or Not?

Posted by on April 28, 2016 under Bankruptcy Blog | Be the First to Comment

Chapter 7 and 13 are very different debt-fighting tools. But that doesn’t necessarily mean it’s obvious which is right for you.

 

The Not Always So Easy Choice

Once it is clear that you need bankruptcy relief, picking the right Chapter to file can be simple. Your circumstances may all point towards one option or the other. But sometimes it can be far from clear cut.

 

The First Impression IS Often Right

To be clear, when my clients first come in to see me, many have a good idea whether they want to file a Chapter 7 or a 13.  There is lots of information available about this, including on this website. So lots of my clients come in having done some homework. Or at least they’ve heard something about the two Chapters and have an impression which makes sense to them.   But sometimes after we have reviewed all the facts and options, the initial impression  proves wrong.

 

An Illustration

Let’s say you have a home you’ve been struggling to hold onto for the last year or two, but by now have pretty much decided it wasn’t worth doing so any more. You’re seriously behind on both the first and the second mortgages. Like so many other people, the home is worth a lot less than you owe. In fact, let’s say you owe on the first mortgage a little more than what the home is worth, plus another $75,000 on the second mortgage, so the home is “under water” by that amount. Although for the last couple of years you’ve been hoping that the market value will start heading back up, but it’s just held steady. You and your family would definitely like to stay there, buy you absolutely can’t pay both mortgages. Besides it makes little economic sense to keep struggling to hang onto property worth $75,000 less than what you owe. So you’ve decided it’s time to give up on the home, and just file a Chapter 7 bankruptcy.

But then you meet with your bankruptcy attorney and find out some surprising good news. Because your home is worth less than the balance on the first mortgage, through a Chapter 13 case you can “strip” the second mortgage off the title of your home. You no longer have to make the monthly payments on it, making keeping your home all of a sudden hundreds of dollars cheaper each month.  In return for paying into your Chapter 13 Plan a designated amount each month based on your budget, and doing so for the three-to-five year length of your Chapter 13 case, you can keep your home usually by paying very little—and sometimes nothing—on that $75,000 second mortgage. At the end of your case, whatever amount is left unpaid on that second mortgages would be “discharged”—legally written-off—so you own the home without that mortgage. You are debt-free, other than your first mortgage.

This “stripping” of the second mortgage is NOT available under the Chapter 7 that you initially thought you should file. The ability to keep your home by significantly lowering its monthly cost to you and bringing the debt against it much closer to its value could well swing your choice towards filing Chapter 13, contrary to your initial intention.

So, the Best Advice:  Meet with Your Attorney with an Open Mind