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Make Your Mortgage More Affordable by Eliminating Other Debts

Americans are up to their eyeballs in debt—an average of more than $8,000 in consumer debt (not counting mortgages) for every man, woman, and child in 2007, according to the Federal Reserve. It’s not uncommon for me to see clients of moderate means who owe credit card debt exceeding $50,000. If you are looking to save your house, and Chapter 13 bankruptcy might get the job done, chances are great that you’ll also greatly reduce, if not eliminate, your debt load. Chapter 13 gives you three to five years not only to work out your mortgage problems but also to deal with your unsecured debt (debt not secured by collateral) once and for all.

To eliminate credit card and other unsecured debt in Chapter 13 bankruptcy, you must be willing to commit all of your disposable income to repaying as much of the debt as you can (taking into account that you must also pay down other debts such as mortgage arrears or recent back taxes) over a three- to five-year period. Any unsecured debt that remains at the end of your plan is discharged (cancelled), unless it is one of the types of debt that survives bankruptcy, such as child support or student loans.

Disposable income is computed in two entirely different ways, depending on whether your income is above or below your state’s median income, and on which judge you end up with. The reason for this uncertainty is that the law regarding disposable income changed radically in October 2005, and the courts are still sorting it all out.

For the vast majority of Chapter 13 bankruptcy filers, disposable income is the income you have left over every month after taxes and other mandatory deductions are subtracted from your wages, you pay necessary living expenses, and you make payments on your car notes and mortgages.

EXAMPLE: Terry’s net income, after mandatory deductions, is $4,000 a month. Out of this must come a mortgage payment of $1,500, a car payment of $500, and $1,800 for utilities, food, transportation, insurance, medical prescriptions, and other regular living expenses. The $200 that’s left over each month is Terry’s disposable income.

If your household income is higher than the median in your state for a household of your size, you must propose a five-year plan. Your disposable income will be partially computed on the basis of IRS expense tables that may or may not match your actual expenses. Also, your disposable income will likely be based on what you earned the past six months, not necessarily on what you are earning now. In other words, the court may rule that you have disposable income even when in fact you don’t. Weird? You bet, and many commentators, including bankruptcy judges, have said so. Nonetheless, this is the result Congress apparently intended in its landmark bankruptcy legislation of 2005.

If your household income is lower than your state’s median, you’ll typically propose a three-year plan—but you may ask for court permission to propose a five-year plan if you need more time to lessen the monthly payments required by the bankruptcy law.

To determine whether you are a high-income or low-income filer, you first compute the average monthly gross income you received from all sources, taxable or not (except for funds received under the Social Security Act) during the six months that immediately precede the month in which you file for bankruptcy. You then multiply that figure by 12 and compare the result with your state’s median income.

EXAMPLE: Justin plans to file for Chapter 13 bankruptcy in June. He lives in California and has four people in his household. He will have to compute his average gross income from all sources (except Social Security) for December of the previous year through May of the current one. It comes out to $6,000 a month. He multiplies this figure by 12 for an annual figure of $72,000. Because the median income for a California family of four is more than $76,000, he qualifies as a low-income filer.

Get free help online. You can use www.legalconsumer.com to help you make these calculations and comparisons. The median income figures change at least once a year.

It’s important to know that you can propose a Chapter 13 plan even if you have very little disposable income to pay down your unsecured debt, and even if you pay off only a small fraction of that debt.

EXAMPLE 1: Rubin owes $36,000 in unsecured debt, consisting of credit cards and personal loans. His income is below the median for his state, and he has $200 disposable income left each month over after paying all his living expenses and monthly contractual debt (a $1,000 mortgage and a $450 car loan). Rubin successfully proposes a plan that will pay his unsecured creditors $200 a month for 36 months. It comes to a total of $7,200, which is 20% of his unsecured debt. The rest will be discharged if he completes the plan.

EXAMPLE 2: Lynn also has $200 of disposable income each month. She has both unsecured debts and $3,000 in missed mortgage payments. In her Chapter 13 repayment plan, a portion of her disposable income will be used to make up some missed payments, and the rest will go to her unsecured debt. For example, if she has a three-year plan, $83 a month would go for the missed payments, and the other $117 would go to repay 12% of the unsecured debts.

Nothing in the bankruptcy law requires a minimum percentage of repayment; it’s left up to the judge. Some bankruptcy judges will accept plans that pay even a smaller percentage of unsecured debt than shown in these examples. In fact, some plans have been approved that pay 1% or even less. But some judges won’t approve a plan unless it provides for repaying a certain higher minimum percentage of debt.