If you own a rental property which has lost value, and worse, you're struggling with the mortgage payment, you may be able to use Chapter 13 to "cram down" your payments to a lower level.
How Chapter 13 Works
Chapter 13 is a type of bankruptcy in which the debtor holds on to his or her property and assets. Instead of liquidating assets to pay creditors before discharging (eliminating debt), in a Chapter 13 bankruptcy, a court-ordered repayment plan (essentially, a budget) is developed for the debtor. Under this plan, the debtor will pay creditors as much as he or she can for 3 - 5 years, after which remaining debts are discharged.
There's a slight wrinkle with secured debt, which is debt which has property as collateral. Mortgages, where the real estate stands as collateral for the loan, is a common example of secured debt. Bankruptcy does not cut off a creditor's security interest or right to foreclose (or repossess, such as in regards to a car loan); therefore, if the debtor cannot make his or her payments on the mortgage or other secured debt, the lender can take possession of the property.
However, that's all the lender can do--the lender gets the property, but the debt is otherwise discharged and no deficiency judgment is possible. That's what leads to the cram down.
Chapter 13 Cram Down
In bankruptcy, the secured creditor is only protected up to the value of the property it can foreclose on or repossess--it can't get anything more than the property itself. That means that if a mortgage's remaining balance is, say, $200,000, but owing to market declines, the property is only worth $125,000, for all intents and purposes, the loan to the bankruptcy filer is only worth $125,000.
Recognizing this, courts will "cram down" the value of the loan to the value of the property. Instead of having to pay the remaining balance on the original loan, what the debtor owes will be recalculated based on what the property is worth at the time of filing. In the above example, instead of paying a mortgage with a $200,000 principal balance, the debtor will only have to pay for a $125,000 principal loan--the new amount based on the property's $125,000 market value.
A debtor's primary residence cannot be crammed down, but investment property--such as rental property--can be. Chapter 13's cram down makes it a powerful option for rental property owners squeezed between declining asset value, a weak economy eroding rental income, and a mortgage they can no longer afford.
How an Attorney Can Help
Experienced bankruptcy counsel can help you present your financial picture and the value of your property in a way that gets you the maximum reduction in loan amount.
