Chapter 13 Bankruptcy: Look Into A Mortgage “Cramdown” to Reduce the Principal Balance of Your Investment or Rental Property
by Richard Fonfrias,
J.D. Chicago’s Financial Rescue &
Fonfrias Law Group, LLC
Under certain conditions, Chapter 13 bankruptcy allows you to reduce the principal balance of your mortgage to the value of your real estate. And, in some cases, you can reduce your mortgage interest rate as well. Both are a welcome relief in reducing your mortgage balance.
Under Chapter 13 bankruptcy, you are permitted to cram down mortgages on your investment real estate. These include real estate such as your rental or commercial properties. You are not permitted to cram down the mortgage on the home you use are your principal residence. You can, however, use other methods such as lien stripping to remove your second mortgage, often called a home equity line of credit (HELOC).
A Mortgage Cramdown Reduces Your Principal Mortgage Balance
If your investment property has gone down in value faster than you have paid down your mortgage, then you are said to be “upside down” in the property. This means that the amount you owe on the property is more than the property’s value. You have probably heard the term “upside down” relating to anything that’s value is lower than the amount you owe on the item, such as your car.
Here’s an example: You bought a rental property – a four-plex – for $400,000. Then the real estate market crashes and its value is now only $250,000. But the mortgage balance that you owe is $350,000. This means you are upside down in the property by $100,000.
Here’s how a mortgage cramdown could help. You can cram the mortgage down to $250,000 (its current value) through your Chapter 13 bankruptcy plan. Your mortgage balance would then be $250,000 instead of $350,000. You would still owe the $100,000 difference but it is now treated as an unsecured debt, like a credit card, because it is no longer secured by your real estate. Through your Chapter 13 plan, you will probably reduce the balance of your unsecured debts a little; however, most of the unsecured debt will be erased at the end of your Chapter 13 plan.
In Addition to Reducing Your Mortgage Balance,
You Could Benefit in These Two Ways
1. Lower mortgage interest rate. When you cram down your mortgage in a Chapter 13 bankruptcy, the court then determines the interest rate you will pay on the loan. Often, the new interest rate is calculated as the prime rate plus a few points, which could be lower than the original interest rate on your loan.
2. You do not owe for a deficiency. In a foreclosure, the lender sells your property for whatever it can get. Then you owe the lender the difference between the sales amount and the amount due on the mortgage, called the deficiency. After a mortgage cramdown, if the lender later forecloses on the property, you are no long liable for the amount that has become unsecured, which usually equals the amount of the deficiency.
But Here’s The Catch
If you get a mortgage cramdown, most bankruptcy courts require that you pay off the new mortgage balance by the end of your Chapter 13 plan, usually three to five years. As a result, your mortgage payments could be very high. Or you’ll need to put a balloon payment at the end of your plan.
In most cases, the bankruptcy court will not allow you to end the plan with a balloon payment unless you can show that you have a way to raise funds to make that payment. As an example, one way might be to sell other income properties that you own. This bankruptcy court requirement often stops people from cramming down their mortgages on commercial property.