S is for Strip in my Bankruptcy Alphabet.? Bankruptcy lawyers delight in stripping liens from people’s homes.

In any chapter of bankruptcy, a debtor can void judgment liens that have attached to assets that would otherwise be exempt.

In Chapter 13, tax liens and other statutory liens can be stripped off the asset if there is no value in the asset, after considering liens that were perfected earlier, for the lien in question to attach to.

But the crowning feat in Chapter 13 is to strip off a voluntary mortgage lien on a home.

When is it possible to strip off a mortgage lien?? In the 9th Circuit, and several other circuits, when there is not a single dollar of value for the mortgage to attach to.? When that’s the case, the Bankruptcy Code says that the lien simply isn’t an allowed, secured claim.? And only allowed secured claims are protected from modification by ?1322.

That’s a long, lawyerly explanation of how Chapter 13 bankruptcy can utterly eliminate thousand or even hundreds of thousands of dollars in debt that once encumbered a home.

The debtor’s ability to strip a mortgage lien is dependent on three things:

1. The value of the home in today’s market
2. The sum of the liens on the home senior to the lien to be stripped
3. Completion of the Chapter 13 plan

During the Chapter 13 plan, the loan underlying the stripped lien is treated and paid (or not) just like all other unsecured claims.

At the end of the Chapter 13 plan, the lien representing the stripped mortgage is forever void, and any personal liability that the homeowner had to the lender is discharged.

Lien stripping alone is enough for homeowners to think about filing Chapter 13 even if the balance of their debts are manageable.

I’m sure my mother never dreamed I’d grow up to be a stripper!

This post has been brought to you by the letter S.

Jay Fleischman, New York bankruptcy lawyer and the guy who started the alphabet madness, claims? S is for Security Interest

Image courtesy of Leo Reynolds.

It’s not the foreclosing creditor that really threaten California homeowners.? It’s the forces that follow, the junior lender and the tax man who can deliver the truly punishing blows to a family losing a home.

Cut-off Junior Lienholders

Californians enjoy the protection of the one action rule governing foreclosures.? It says that a creditor who conducts a non judicial foreclosure of its security interest cannot collect anything more than the property it forecloses on.

Foreclosure is, as lawyers say, an election of remedies.? When the lender chooses to foreclose, it gives up the right to pursue the borrower for anything more.

But, the typical foreclosure sale destroys all liens on the property that are junior to the foreclosing creditor.? The HELOC lender, the second deed of trust, the SBA loan are rendered unsecured by the sale.? Unless the junior lien was created as part of the purchase of the property, the cut off junior lienholder CAN sue you for what’s owed on the debt.? The limitation on purchase money lenders suing you personally is often called the “antideficiency” statute.

So, if foreclosure is in the cards, you need to have a plan for dealing with the other players who no longer have a lien on the real property.? There’s a four year statute of limitations on collection actions, so the problem doesn’t go away quickly.

Cancellation of Debt Income

The tax code provides the second blow in these unhappy circumstances:? debt that is forgiven may be treated as if it were cash received by the borrower whose debt is satisfied for less than was owed.

In an era of falling home prices, homeowners more often receive a 1099 following the foreclosure sale that reports the difference between the fair market value of the property foreclosed and the amount of the debt owed to the foreclosing creditor.? Unless you fall into one of the exceptions found on IRS Form 982, the difference between those two numbers is reported as income on your tax return.

There is? temporary relief? from federal income tax through 2012 if the property foreclosed was the owner’s principal residence to the extent the loan was used to buy the property.? Relief under state law varies.

Impact of Bankruptcy Filing

A bankruptcy filing before a foreclosure sale eliminates both the liability to the junior lien holders and the possibility of tax liability on forgiven debt.? Tax law provides that debts forgiven in bankruptcy don’t generate cancellation of debt income;? a bankruptcy discharge wipes out any exposure to suit by the cut off junior lien holders.

It’s worth noting that a short sale may expose the homeowner to cancellation of debt income.? California law now requires that lien holders who consent to a short sale waive their rights to sue….so forgiveness of the debt is mandated.

Facing foreclosure is a stressful time, but it pays to look at the possibilities for collateral damage before you resign yourself to going through foreclosure.

People are desperate to save their homes;? scammers are pleased to part them from their money.

Two Bay Area men were convicted this week of foreclosure consultant fraud.

The men took money from homeowners seeking loan modifications.? Sounds innocent enough, until you recall that California law prohibits anyone, even an attorney, from taking money in advance to provide loan modification or foreclosure prevention .

California Civil Code Section 2944.7 reads
(a) Notwithstanding any other provision of law, it shall be
unlawful for any person who negotiates, attempts to negotiate,
arranges, attempts to arrange, or otherwise offers to perform a
mortgage loan modification or other form of mortgage loan forbearance
for a fee or other compensation paid by the borrower, to do any of
the following:
(1) Claim, demand, charge, collect, or receive any compensation
until after the person has fully performed each and every service the
person contracted to perform or represented that he or she would
perform.
(2) Take any wage assignment, any lien of any type on real or
personal property, or other security to secure the payment of
compensation.
(3) Take any power of attorney from the borrower for any purpose.
….
(d) This section shall apply only to mortgages and deeds of trust
secured by residential real property containing four or fewer
dwelling units.
(e) This section shall remain in effect only until January 1,
2013, and as of that date is repealed, unless a later enacted
statute, that is enacted before January 1, 2013, deletes or extends
that date.

The take away for borrowers is that anyone who asks for money up front to help prevent foreclosure or modify a loan is breaking the law.

The unfortunate effect of the law, designed to protect homeowners from those trying to exploit them, is that it also operated to make it very difficult for legitimate professionals to provide these service if they have to wait til the successful conclusion of the loan modification for payment.

You can find a free HUD certified foreclosure counselor at http://hud.gov or Foreclosure Help Hotline? 408 794 1242.
Image courtesy of Fotolia.com

An amendment effective January 1, 2011 allows the trustee under the deed of trust to record the notice of sale up to five days before the 90 day cure period has run.? The total elapsed time between the recorded notice of default and the actual foreclosure sale on the courthouse steps has not changed.

Here is the change in Civil Code? ?2924(a)(4).

Notwithstanding paragraph (3), the mortgagee, trustee, or
other person authorized to take sale may file a notice of sale
pursuant to Section 2924f up to five days before the lapse of the
three-month period described in paragraph (2), provided that the date
of sale is no earlier than three months and 20 days after the filing
of the notice of default.

In the real world, I doubt that foreclosures will happen any quicker than they did before this change.? I do have to wonder where the legislative support came from to make the lives of foreclosing creditors easier.

Image courtesy of TJOwens.

I’m fond of her piece especially since she includes my lament that I spend my days talking people out of houses. My rallying cry, so often, is “live there payment free until the sale.” My input on underwater houses and the bankruptcy option is slated to be the last article in the series.

Can you afford to cram down a mortgage when cram down is permitted?

Mortgages on a debtor’s home are protected from cram down in Chapter 13 by 1322(b)(2).? Mortgages on any other kind of real estate can be reduced to the value at filing of the collateral securing the debt as of the date of the filing of the case.

The practical dilemma posed by cramming down partially secured mortgage liens in Chapter 13 for us in the 9th Circuit has been the decision in Enewally. The debtor’s plan sought? to reamortize the reduced claim over the remaining loan term.? Enewally held that the reduced secured claim had to be paid in full during the life of the plan.

With the constriction of mortgage lending that has put refinancing out of reach and the BAPCPA provisions that secured claims be paid in equal installments, the real world utility of the right to strip down a lien is highly restricted.

So, I was tickled to see the court in Elibo, 447 B.R. 359 ( S.D. FL 2011) , hold that the debtor could reduce the debt to the current value of the collateral while maintaining the term of the loan.

Elibo is a trial court opinion outside of the 9th Circuit, so it has no immediate answer to the issue here in the 9th, but it is a beginning on what I hope is a judicial dialogue about cram down and long term debts.

The last time I wrote about cancellation of debt and the possible tax surprise on foreclosure or short sale, I couldn’t lay my hands on the form the IRS provides to calculate insolvency. Found it!

IRS publication 4681 contains the worksheet along with an explanation of the application of the principal that, absent an exception, debt cancelled without payment is just like cash in the bank.

My life is simplified because debt discharged in bankruptcy generates no tax consequences to the borrower.

See earlier post on cancelled debts, and the tax consequences of foreclosure.

Image courtesy of danielmoyle.

1. A voluntary lien, like a deed of trust securing a second loan, line of credit, or HELOC, can be voided only in Chapter 13 or Chapter 11.
2. It can be stripped only if there is no equity in the property after deducting the payoff balances of the liens senior to the lien from the fair market value of the property.
3. The lien is permanently voided only upon the successful completion of the reorganization plan.

Thanks to lobbying by the mortgage lenders nearly twenty years ago, bankruptcy courts are prohibited from compelling any changes to mortgages liens secured only by the debtor’s home.? Stripping junior liens is permitted only when the lien to be stripped is not secured by any value at all in the property that is the collateral.

As a result the help for homeowners that can be provided by a bankruptcy reorganization is ? limited to voiding totally unsecured liens and to eliminating other debts of the homeowners. ? The bankruptcy court cannot require the senior lender to modify a mortgage or to defend its decision to reject a modification.

Legislation passed by the House of Representatives in 2009 would have overturned the prohibition on modifying home loans and allowed judges to reduce mortgage balances to the present value of the home and alter other terms of the loan if the borrower was willing to file bankruptcy and successfully made the plan payments.? The Senate defeated the bill, so bankruptcy judges remain powerless to weigh in on the tug of war between the mortgage bankers and the homeowners.

As always in a down real estate market, you need to determine whether you should keep the house. and what the viability of a modified mortgage is.

You’ve got choices for a house even after you file bankruptcy.

Image courtesy of madnzany

I got a good data point today from a client in a pending Chapter 13 filed late in 2009. ? The client has not made a payment in 17 months. ? The confirmed Chapter 13 plan provides that the debtor will surrender the house and grants the creditor relief from stay. ? The lender just denied a loan modification. ? And the creditor has not yet taken the first, legally mandated step in the foreclosure process!

So, even if the lender starts foreclosure tomorrow, it will be September, almost two years from the filing of the bankruptcy case before title to the house changes hands.? And I am fairly confident that the lender will not initiate foreclosure proceeding immediately, and even more confident that they will not be perfectly efficient in doing so.

The future is not predictable, and what is true today may not be true tomorrow, but it is clear that lenders are not in a hurry to own more California real estate.

Be prepared with answers when clients ask:

• Should I try for a short sale?
• What does this 1099 mean?
• Are there tax consequences of a loan modification?

Bill Purdy, tax professor and real estate law practitioner, will discuss recourse and non recourse debt and the tax consequences of foreclosure.? The workshop runs 2 hours and MCLE credit is available. Advance sign up is required.

The program will be available later electronically. ? If you want to be notified when the electronic version is ready, send an email to cathy@law-full.com.