Removing Second Mortgages though Lien Stripping

October 31st, 2008, 4:19 pm

LIEN STRIPPING PODCAST 

In the present economic times many individuals are living with financial decisions causing them to hold assets, such as houses, automobiles and boats, whose values have plummeted. Individuals are living in properties whose values have dropped far below the mortgages or driving cars, which are valued at a third of the loans. Those individuals with financial difficulties are looking for assistance through the bankruptcy courts in an attempt to get out from underneath all of the debts and liens acquired, which now vastly exceed their current assets.There are two types of liens, which can be attached to an individual’s property or assets. The first is a voluntary lien, which is basically a situation where you have agreed to use the asset as collateral for a debt, i.e. mortgages and auto loans. A non-voluntary lien is one that a creditor imposes on you and that gives them the right to force you to sell the asset so that they can be paid, for example: judgments against you or tax liens. These liens are either secured or unsecured as to the asset they are attached to.

The most common issue for an individual nowadays is the situation where a homeowner who has a first and second mortgage on a primary residence is facing bankruptcy and wondering if they have the ability to save the family home. As real estate markets fall and the fair market values of the homes fall, homeowners are left with mortgages that far exceed the current fair market value of their homes. There is a process which could be of help to many in this situation and it is called “lien stripping”.

“Lien stripping” refers to the process of reducing a secured claim to the value of the underlying collateral. It uses the combined effect of 11 U.S.C.A. § 506(a) and 11 U.S.C.A. § 506(d) to bifurcate the lien into secured and unsecured. The secured lien is allowed in the amount up to the fair market value of the property at the time of the stripping. The balance of the lien, which exceeds the fair market value of the property, is now deemed unsecured.

Liens can be stripped off of the debtor’s assets in Chapter 11 or Chapter 13 when there is not enough equity in the assets. Section 506(a) and 506(d) of the Bankruptcy Code acknowledges that a lien is only a secured claim to the extent there is value in the asset to which it attaches. To the extent that the claim exceeds the value of the collateral, that portion of the lien is now unsecured. The most common application of lien stripping is the reduction of car loan liens to the present value of the vehicle however it is currently used more often with home mortgages in bankruptcy situations. Lien stripping with car loans has been limited to vehicles purchased over 910 days.

The Bankruptcy Code does permit a bankruptcy plan to “modify the rights of holders of secured claims, other than a claim secured only by a security interest in real property that is the debtor’s principal residence”. Section 1322 (b)(2). This section provides protection to the holder of a claim secured only by a lien on the debtor’s principal residence by prohibiting any modification of the terms, however the issue arose as to if this section precluded “lien stripping” of undersecured residential mortgages in the face of Bankruptcy Code section 506 which appears to permit bifurcation of undersecured mortgages and voiding of unsecured portions of the mortgage lien. At least two bankruptcy court judges sitting in Massachusetts have permitted such bifurcations, see In re Brown, 175 B.R. 129 and In re Richards, 151 B.R. 8.

In any event, there is an exception as to the lien on a principal residence lien and that is if there is a second or third lien on the same property. In this instance those liens, lien stripping is available to render them totally unsecured if the first mortgage balance equals or exceeds the value of the personal residence. The exception is only if there are two distinct mortgages on the property, not a refinancing situation. It should also be noted that the limitation of lien stripping of first mortgages only apply to personal residences, it will be allowed for a mortgage on a building used for business or renting.

As always, all situations relative to a strategy for bankruptcy and lien stripping should be discussed in detail with a bankruptcy attorney to understand all your avenues open to you.

Filed under Bankruptcy, Foreclosure, Post Petition Protection · 1 Comment

The Difference between Chapter 7 and Chapter 13 of the Bankruptcy Code

October 20th, 2008, 2:53 pm

 DISCUSSION OF CHAPTER 7 VS. CHAPTER 13 BANKRUPTCY PODCAST
Individuals who have amassed large debts have many options. However, if an individual finds that non-bankruptcy alternatives are not feasible, a decision then must be then made between filing a Chapter 7 liquidation proceeding or a debt adjustment proceeding under Chapter 13.A Chapter 7 bankruptcy filing is best described as obtaining a discharge from debts (with some exceptions) while retaining some assets such as a home, household goods and an automobile as long as they do not exceed certain values determined by the U.S. Bankruptcy Code. Chapter 7 is consider a “liquidation” decision however if filed correctly and using the Bankruptcy Code to the best of your ability some assets can be retained while crushing debt is removed.

To be eligible to file a Chapter 7 bankruptcy the filer has to reside or be domiciled in the United States. In addition, they can not have been a debtor in a bankruptcy case in the 180 day period prior to filing the current bankruptcy case; they must receive counseling from an approved nonprofit budget and credit counseling agency prior to the filing and pass the “median family income” test. In order to receive a discharge in a Chapter 7 an individual may not have received a Chapter 7 bankruptcy discharge in the previous eight years or a Chapter 13 discharge in the previous six years.

The element which will fully determine if you can file a Chapter 7, is the “median family income” level. The individual or couple must review income made within the previous six months and average it out. If when the average income is measured against the “median family income” as stated in 11 U.S.C. § 707(b)(7) and it falls below, then a Chapter 7 filing is appropriate. If the household income exceeds the “median family income”, then the individual or couple will be subject to the means testing. The means testing calculation takes the average amount of the income received during the six-month period prior to the bankruptcy filing and subtracts it from the average monthly expenses. This determines the margin of excess income. Using this figure you determine if the excess income exceeds the margin allowed by 11 U.S.C. § 707(2)(A)(i) and if you are eligible to file a Chapter 7 bankruptcy.

If you are unable to file for Chapter 7 due to the “median family income” level being too high and failing the means testing, then your other option is filing a Chapter 13. A Chapter 13 bankruptcy filing allows a person to seek protection of their property and develop a plan of paying creditors by making monthly payments to a Trustee under Court supervision. The plan can be for as little as 24 months or for as long as 60 months.

To be eligible to file a Chapter 13 bankruptcy the filer must reside in the United States, have a regular income, have unsecured debt less hand $336,900 and secured debt less than $1,010,650 and receive counseling from an approved non profit budge and credit counseling agency. In order to obtain a discharge in a Chapter 13 an individual must not have been granted a discharge in a Chapter 7 bankruptcy in the previous 4 years or been granted a Chapter 13 discharge in the last 2 years.

The primary advantage of a Chapter 13 filing over a Chapter 7 filing is that a debtor by paying a portion of his or her pre-bankruptcy debts over the life of the Chapter 13 plan can obtain a discharge of the unpaid balances while retaining all of their asset, avoid foreclosure of a home and more debts are deemed dischargeable in a Chapter 13 verses a Chapter 7.

The disadvantages to a Chapter 13 verses a Chapter 7 is that the filer will have to pay something to unsecured creditors, a reduced amount against entire debt. However in a Chapter 7 filing it could result in a discharge from most or all pre-bankruptcy obligations without any payments. Another disadvantage to a Chapter 13 is that a discharge will not be received until all payments required by the plan are done whereas a Chapter 7 debtor will usually receive a discharge in three to five months from filing.

It is essential that when trying to figure out if bankruptcy is the right option to contract an attorney to discuss the entire matter, review your current financial situation, determine what is most important to keep and let go and decide which is the best plan for their situation.

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Trusts may not protect your assets from creditors

October 8th, 2008, 8:54 pm

An individual’s largest asset is usually their homes. In an attempt to keep these large assets in the family and to avoid probate, individuals are either gifting the homes away to children early by signing over the deed or setting up a living revocable or irrevocable trust. Unfortunately sometimes these instruments are not used properly, don’t take in all that needs to be done in estate planning and could cause harms not initially apparent when initially create them.Trusts are used to manage assets. They can be set up to accomplish any number of goals such as providing income for a child, grandchild or other family member or it can provide income for a favorite charity or distribute assets in an attempt to reduce tax consequences or security assets from those inevitable issues that come with aging.

If you are setting up a trust in order to protect your assets from creditors or other unforeseeable situations which may arise as you age you must look at both types of trust closely to determine which is best for your circumstance. There are two types of living trusts, revocable and irrevocable. The difference being that the revocable trust can be changed or modified, giving the creator the flexibility of continued control over the assets during his lifetime. The other type of trust is an irrevocable trust. Once an irrevocable trust is established it cannot be changed. The creator will have no access or control over the assets any further through their lifetime once it is placed in the irrevocable trust. Some individuals do not like particular aspect of irrevocable trusts. They want the protection of the trust however they do not want to give up all control of their assets. Depending on what needs to be done in the protection of the assets, an individual might have to give up all control over the property in order to get the protection necessary from creditors or lien holders.

It is important to understand prior to forming such an instrument, that general creditors may use the Uniform Fraudulent Transfer Act (UFTA) under G.L. c. 109A to void or rescind a transfer by a individual debtor for less than fair consideration, regardless of whether the transfer is to an individual or a trust. The Fraudulent Transfer Act can be used by an individual’s creditor if they can show that: 1) the debtor had “actual intent” to “defraud either present or future creditors”; or 2) the debtor believed “that he will incur debts beyond his ability to pay as they mature”; or 3) even if there was no fraudulent intent, the debtor was “thereby rendered insolvent”. What this act will do is render an individual’s trust void and rendered charges against the individual for a fraudulent transfer. This “look back” period as it is called is a statute of four years. If for example an individual has placed a piece of property into a trust and then enters a nursing home the creditor or Medicaid will look back four years from the date of incurring the charges to see if any property was transferred. If such property was transferred and the intent is considered fraudulent then the trust is considered void and the nursing home will be able to attach the home for charges incurred.

Also prior to placing assets into a trust the individual must understand that in bankruptcy, debtors must report all transfers made within one year of signing the bankruptcy petition. In conjunction with the one year “look back” period in bankruptcy, creditors may also use the Fraudulent Transfer Act to reach assets that have been transferred without fair consideration within their four year “look back” period as well.

If after discussing all aspects of why you need an instrument for estate planning with your attorney understanding the difference in the instruments, what they can and can’t do is the next step. While a revocable trust gives the individual the ability to continue to control their assets, this control makes it impossible for the trust to offer any protection to an individual from creditors seeking to collect on a debt. “The established policy of the Commonwealth long has been that a Settlor (person who creates the trust) cannot place property in the trust for his own benefit and keep it beyond the reach of his creditors”. Merchants Nat’l Bank of New Bedford v. Morrissey, 329 Mass. 601, 605 (1953). Under State Street Bank & Trust Co. v. Reiser, 390 Mass. 864 (1984), and those cases following, after the settlor’s death, creditors of a settlor also have access to any and all trust assets that the trustee could have distributed during his lifetime. The plain meaning is that a revocable trust offers no creditor protection to the creator of such a trust.

A revocable trust may also result in loss of homestead protection and right of survivorship. A homestead or homestead exemption means that your home is protected from creditors up to the limit of the exemption for as long as the house is your primary residence. A homestead prevents most creditors from taking the house away from you to satisfy a debt that you owe the creditor. It will also protect your home in the event that you have to file for bankruptcy. If the home is placed in a trust, the homestead does not work. The home is no longer a primary residence, it is placed in the trust name and is no longer in your name. The placing of the home in a trust also will break the right of survivorship relative to a spouse that survives you.

An irrevocable trust in turn will protect you from your creditors as long as the trust is created in such a way the individual has no control over the trust asset for which it was made. In making any type of long term estate plan it is the best policy to speak to an attorney regarding your assets, your long term planning, and how you would like to manage such assets during and after your lifetime. Due to the “look back” period this should be done sooner rather than later.

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