Bankruptcy Court allows "Chapter 20" debtor to remove a mortgage from her home

One of the benefits of filing a Chapter 13 Bankruptcy case (where an individual can "reorganize" through a plan providing for payment of creditors over 3 to 5 years), is that Chapter 13 allows some forms of  mortgage modification not available elsewhere. Specifically, under certain circumstances junior mortgages can be "stripped off" a home, leaving the borrower with a home that is less financially "underwater". It goes like this:
Let's assume your home is worth $200,000.00 but the first mortgage payoff is $201,000.00. The second mortgage and third mortgage are worthless, because there is zero equity for those lenders. If the home were sold, the first mortgage holder takes it all. When this is the case, in a Chapter 13 case, the borrower can, through her bankruptcy plan, convert these worthless mortgages into unsecured debts. After she completes her plan, the mortgages are "stripped off", leaving only the first mortgage.

This is a big benefit. However, Mrs. Gloster did not have enough income to support any payments to her creditors, so she had to file a Chapter 7 bankruptcy (where "strip off" is not allowed). She got her discharge. This meant that she no longer had any personal liability on either of the two mortgages on her home, but to keep the home she still had to keep paying the first and second mortgages. In her case, the home was worth $182,000. Chase had a first mortgage with a balance of $200,200, and Bank of America ["BOA"] had a second mortgage with a balance of $51171.00. Apparently she was resigned to losing the home. She was behind on both mortgages.

After she got her Chapter 7 discharge, Mrs. Gloster's fortunes changed. She got a raise, and she got Chase to reduce her payment on the first mortgage. This meant she now had some money to fund a Chapter 13 Plan. To save her home, Mrs. Gloster filed a "Chapter 20", ie a new Chapter 13. She did not have to discharge any debt; indeed she could not do so. But what she proposed was to remove the BOA second mortgage through a "strip off" and use monthly payments to bring her first mortgage current.

The problem is that courts around the country disagree whether Mrs. Gloster could do this. Some courts held that a Chapter 13 debtor who is ineligible for a discharge, loses the right to "strip off" mortgages as well  Until now, no New Jersey court had issued a published opinion on this point. In In re Gloster, issued October 13, 2011 for publication, Judge Novalyn Winfield, in a carefully reasoned opinion, held that this use of Chapter 20 was allowed, so long as the second bankruptcy filing was made in good faith.  Judge Winfield reviewed the existing case law, but was persuaded that nothing in the plain and direct meaning of the bankruptcy code provisions involved prevented Mrs. Gloster from doing what she proposed.

The opinion cautions that a debtor using Chapter 20 this way must demonstrate good faith. Factors to be considered on this issue include (1)whether the debtors have a need for bankruptcy other than lien avoidance [Mrs. Gloster needed to cure mortgage arrears to save her home]; (2)whether debtors acted equitably in proposing the plan [here there were some small payments to be made to non-mortgage unsecured creditors]; (3) whether debtors are devoting their income to the plan [Mrs. Gloster was]; and (4) whether the debtors used serial filings to avoid paying their creditors [Mrs. Gloster could not qualify for Chapter 13 when she filed her Chapter 7, because of lack of income. The mortgage lenders were no worse off than they would be otherwise]

This is a welcome clarification. It also illustrates how, with the proper guidance and under the right circumstances, borrowers can use Chapter 13 to save their home. For more guidance and help with mortgage modification and use of Chapter 13, see our website: Alternatives to Foreclosure