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Why Chapter 13 Bankruptcy may not be able to save some Bay Area homeowners from forclosure

As a Bay Area bankruptcy attorney, I know first hand that for many people in California, the dream of owning their own home became a nightmare when the housing bubble burst in 2007. Trapped in mortgages they no longer could afford, homeowners quickly saw any equity they may have had in their homes slip away. Gone was the nest egg they thought they had provided for themselves. Real estate investment, which up until that point was considered a sound investment, a certified “sure thing,” over night became the money pit for thousands of California home owners.

In an effort to try to save their homeownership dreams and still afford to eat, many people looked to bankruptcy as an option. For thousands of people, Chapter 13 helped them catch up on their mortgage arrears and keep their home. But for countless others, chapter 13 bankruptcy could not provide the “fresh start” the bankruptcy code promises. This is because of the debt limits that are provided for in Chapter 13 bankruptcy. Under the code, the cap on unsecured debt is $360,475 and the limit for secured debt is $1,081,400. While these limits may seem easy to pass, for many home owners the amount of their mortgage alone instantly excluded them from chapter 13 eligibility because their mortgages were above the secured debt limits.

As people living in California, and especially the bay area, know, housing prices are well above the national average. Million dollar homes, while not the norm in bankruptcy, are neither the exception. This means that for some, the very reason they were looking towards bankruptcy relief, to save their home, is the very reason they were not eligible for that relief in a chapter 13 context. Instead of being able to repay their mortgage arrears through a chapter 13 plan, these high mortgage debtors were forced to either consider a chapter 11 bankruptcy which is incredibly expensive and not particularly suited for this type of individual case, or negotiate directly with their lender without the protection of bankruptcy. Often times, neither of these options was successful and homes were lost to foreclosure.

A wonderful benefit of a Chapter 13 bankruptcy is the ability for homeowners to strip off a second mortgage. This is allowed only when the first mortgage is higher than the value of the home. So if you owe more money on your first mortgage than your home is worth, you can strip off and discharge the second mortgage through your chapter 13 case. However, many high mortgage debtors ran into debt limits issues trying to utilize this very tool. In order to strip off a second mortgage, you have to show that the debt is unsecured. You must show that there is no equity in the property to secure the second mortgage lien. Once you’ve done that you have to classify that debt in the bankruptcy plan. Courts have consistently held that this stripped off second mortgage must be classified as unsecured debt and is therefore subject to the chapter 13 unsecured debt limit of $360,475. It is easy to see how a homeowner could be disqualified from chapter 13 due to their stripped second mortgage plus their other general unsecured debt like credit card debt, student loans, and medical bills. If a person had a $200,000.00 second mortgage plus another $150,000.00 in credit card debt then they technically would be ineligible for a chapter 13 bankruptcy.

Some attorneys have decided to challenge the debt limits of chapter 13, arguing that the limits are unconstitutional. This argument is premised in the 14th Amendment’s Equal Protection Clause. The argument goes as follows: Similarly situated debtors are being treated differently due to the geographic area in which they live. Because debtors in California are subject to much more inflated housing market than Debtors living in say, Ohio, they are being excluded from chapter 13 relief whereas Debtors in Ohio are not.This argument is currently before the 9th Circuit Court of Appeals in the case Santos v. Dockery. Hopefully, the 9th Circuit will decide to allow all debtors the same opportunity to save their homes.

The Law Offices of Melanie Tavare is a debt relief agency. We help people file for bankruptcy relief under the Bankruptcy Code

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