Eliminate Second Mortgage in Colorado Chapter 13 Bankruptcy

January 19, 2012

By: David M. Serafin

For Colorado residents who own a home worth less than what is owed on a first mortgage, a second mortgage can be removed in chapter 13 bankruptcy under Section 506 of the United States Bankruptcy Code.  Especially as home prices have gone down over the past few years, many upside down homeowners in Denver and other parts of Colorado are eligible to eliminate the negative equity and pay back far less than the second mortgage balance (and interest which would otherwise accrue) over three to five years with a fixed, interest free repayment to the chapter 13 trustee.  As a Lakewood and Littleton lawyer for chapter 7 and chapter 13 filings, I even represent many clients who pass the Means Test and otherwise qualify for chapter 7 debt elimination but who opt for chapter 13 to get rid of the second mortgage.  I jokingly but truthfully tell these clients that (in way) they are making money by filing for chapter 13 if the plan payment will be less than the now foregone second mortgage payment.   

Here’s an example of a situation whereby we can eliminate the second mortgage.  The house valued at $400,000 by a realtor.  The first mortgage balance is $420,000 and $50,000 is owed for the second mortgage.  Here, the Bankruptcy Court may find that the second lien is wholly unsecured (just like low priority debt such as from medical bills, unsecured loans, credit cards and resulting debt for a previously foreclosed house).  

Unsecured debt may be paid back anywhere from 0% to 100% depending on whether the bankruptcy filer has monthly disposable income under the Means Test. A below median income filer (with a low enough household income in relation to household size) and somebody with high enough expenses to pass the Means Test can file for chapter 13, strip off the second mortgage and still pay back nothing to unsecured creditors.  Even a debtor failing the Means Test with disposable income may be paying only a small portion of the unsecured debt, including the second mortgage, in chapter 13 – interest and fee free.  But, unfortunately, removal of the second mortgage for an underwater home will not benefit a higher income earner who will still need to pay ALL debts, regardless of Priority, within five years.    

For some Colorado residents wanting to save their home from foreclosure, it’s possible to simultaneously pay back past due or late mortgage payments on the first mortgage interest free and stop a foreclosure sale, AND get rid of the second mortgage entirely.  Here, it will not be necessary to make up later payments for the second mortgage if you are eligible under Section 506.

The one danger of Section 506 is that – should a bankruptcy filer under chapter 13 fail to timely make plan payments to the trustee or otherwise has their case dismissed – the second mortgage (and all accompanying monthly payments, interest, late fees and possibly the mortgage company’s legal fees) will be revised retroactively back to the date the case was filed.

Please contact Denver bankruptcy lawyer David M. Serafin if are struggling with debt, want to save your Colorado home and feel like you may be eligible to eliminate your second mortgage.

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