Reduce Mortgage Principal to Fair Market Value with a Bankruptcy Cram Down

I had a client ask if there was a way to reduce the principal on a mortgage through a bankruptcy proceeding. The short answer is yes and no. Current bankruptcy law allows a debtor to "cram down" the principle on a mortgage to fair market value (FMV), but only for investment properties. Unfortunately for homeowners who have become upside-down on the mortgage, this rule cannot be applied to your primary residence, or "homestead". There are other ways to help save a home using bankruptcy, but those are outside the scope of this article.

Cramming Down Your Mortgage Principal

In general, once under bankruptcy protection, any mortgage loans which have become greater than the value of the real estate can be crammed down to FMV. Then, the loan can be repaid over the period of the repayment plan, which is usually five years.

Here is an example of how it would work: Let’s assume you purchased some real estate as an investment for $200k last year, but it has since dropped in value to $100k. Using the above mentioned cram down rule, you could reduce the principle to 100k, effectively eliminating one hundred thousand dollars of debt.

One Big Caveat to this Rule

The main thing to be aware of, is that you must stick to the agreed upon repayment plan in order for the bankruptcy court to offer this protection. During the course of a chapter 13 bankruptcy proceeding, a repayment plan will be worked out, designed to match your current income. As long as you stick to the repayment plan, you will be allowed to cram down your mortgage principal.

However, any failure to make all the payments to the bankruptcy trustees as per the plan may be cause for dismissal and the original principal balance would have to be repaid.

In most cases, honest debtors should be able to make the payments as agreed, and if there are any changes in income that make the payment unreasonable, it is possible to petition the court to reassess your situation.

Talk to a Bankruptcy Lawyer

If you are considering bankruptcy as a means of getting out from under insurmountable debt, talk to a bankruptcy lawyer to find out what options are available to you. An experienced bankruptcy attorney should be able to offer you guidance and advise you on some clever strategies that can help save you a lot of money, and eliminate debts to give you a clean financial slate.