Chapter 13 Severance: A Simple, Yet Powerful, Tool for Wealthy Homeowners
The Chicago foreclosure crisis is far from over. In fact according to RealtyTrac,
during the month of July, nearly 12,000 Chicago area homes received a
foreclosure notice - an area including Cook, DuPage, Lake, Kane, McHenry,
Kendall and Will counties. This represents an increase of 37 percent when
compared to July 2011. In addition, foreclosure proceedings started on
more than 7,500 homes during June and July in Cook County alone. While
these numbers seem almost frightening, as usual they do not give the entire
story surrounding the current foreclosure crisis.
When most people think of foreclosures, then generally think of homeowners
who have fallen on hard times and simply cannot afford their mortgages
payments any longer. However, given the unprecedented housing market bust
of recent years, many homeowners are simply not paying their mortgages
because their home is significantly underwater - meaning their home is
now worth much less than the outstanding mortgage on the property.
Even homes owned by affluent homeowners have not been spared from this
underwater home plague - with some higher-end homes even facing more drastic
underwater mortgage issues because, for example, the impact of a 10 percent
value drop in a $1 million home is far greater than that of a $250,000 home.
However, if these homeowners were to simply stop paying their mortgages
because they were underwater, their bank may eventually seek a deficiency
judgment against them after the home is sold during foreclosure proceedings
- which is when the bank seeks the difference between what is still owed
on the mortgage and what the home is actually sold for.
These affluent homeowners can likely afford their mortgage payments, but
since their home has decreased in value so much, they feel they are just
shoveling money down a hole. One option for these wealthy homeowners is
to file for Chapter 13 bankruptcy and to consider a
Chapter 13 Severance of their home to their lender.
Chapter 13 Severance
Many wealthy homeowners simply make too much money to be eligible for a
Chapter 7 discharge, and since they have large incomes, banks are not
likely to discuss any kind of settlement on their underwater homes since
they can afford their mortgage payments. However, in situations such as
these where homeowners likely have incomes over $100,000, Chapter 13 severance
provides an enticing option with a predictable outcome.
Basically, a Chapter 13 severance is when a homeowner files for a
Chapter 13 bankruptcy and then severs their mortgage from the home's promissory note in
full satisfaction of the secured claim.
For example, imagine a couple named Blake and Crystal, who are both doctors.
They make well over $100,000 a year, but currently live in a house only
worth $400,000 even though they purchased the home for $800,000 and still
owe $600,000. Further imagine that their mortgage payment is $7,000 a
month, including taxes and insurance - meaning they will pay a total of
$420,000 over five years on a home currently only worth $400,000. Keep
in mind that this number doesn't even include the money that Blake
and Crystal will spend on home maintenance. Since they will likely not
recover any equity for many years, a Chapter 13 severance may make sense
for Blake and Crystal, even if they can afford their current monthly payments.
After filing for a Chapter 13 severance, Blake and Crystal continue to
retain the title in their home, but they have now severed their personal
liability for the $600,000 still owed to the bank - meaning they now owe
the bank nothing on that secured claim. Also, while this entire process
is going on - usually 12 to 18 months - Blake and Crystal will likely
be able to stay in their home and will not have to make any mortgage payments.
During this time, they are free to attempt to negotiate with their bank
in an attempt to get better terms, but even if they choose to leave, the
bank cannot pursue Blake and Crystal for a deficiency judgment - for example,
if they bank sells the home for only $350,000 even though Blake and Crystal
still owed $600,000. They are completely free from this liability. In
addition, Blake and Crystal's credit will likely recover quickly since
most Chapter 13 repayment plans required repayment within three to five years.
It is important to note that this article barely scratches the surface
of this complex and intricate Chapter 13 severance process - and as such,
this article should not be considered legal advice. However, if you believe
that a Chapter 13 bankruptcy or severance may be helpful to you, it is
important to speak with an experienced bankruptcy attorney in your area
to be advised of your options.