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Mortgage Cramdown In A Chapter 13 Bankruptcy?

Cramdown.jpgIt is well established that the holder of a first mortgage can't modify the terms of the loan if the loan is on his primary residence. However, what if the mortgage is on a rental property which is not the debtor's primary residence, can the terms of the first mortgage be modified? Yes in a Chapter 13 bankruptcy, subject to strict rules.

You can use a Chapter 13 bankruptcy to cramdown the mortgages on your investment properties. Investment property generally means any property other than your principal place of residence such as rental or commercial properties. You cannot use a mortgage cramdown to reduce the balance of your mortgages on your principal residence. However, you may still be able to get rid of your second mortgage on your principal residence in Chapter 13 bankruptcy through a process called lien stripping.

I have advised debtors that, under certain very specific circumstances, to move out of the home, rent it out on a month to month basis, rent an apartment, file a chapter 13 bankruptcy, cramdown their first mortgage, and then move back into their home. (Since the debtor rented their home on a month to month basis, they can terminate the tenancy at any time). Is this bad faith? That can only be answered on a case by case basis.

This brings up the very next question, at what point in time is it determined if the subject piece of property is the debtor's primary residence or rental property not his primary residence?

That question was recently decided in the case of In re Benafel.

The material facts in this case are undisputed. In 1996, Benafel purchased a house in which she occupied as her principal residence. One West Bank was the holder of the first mortgage. Benafel contacted One West in July 2009, to inform the lender that she would have difficulties meeting her mortgage payments because she was no longer employed. When discussions between Benafel and One West produced no solution to her mortgage payment problems, Benafel defaulted and, in October 2009, One West served Benafel with a notice of a nonjudicial foreclosure. After several delays, a foreclosure sale was set for March 25, 2010.

Attempting to avoid foreclosure, Benafel sought a renter for the Property. Sometime in March 2010, Benafel leased the Property to another person, who moved into the Property.

Benafel filed a chapter 13 petition on March 24, 2010, the day before the scheduled foreclosure sale on the Property. On April 12, 2010, she filed a proposed chapter 13 plan (the "Original Plan"). The Original Plan provided that she would make payments to the trustee of $3,065 per month for sixty months. Of that total, Benafel proposed to pay $2,735 per month to One West in full satisfaction of its allowed secured claim for the debt secured by the Property. Benafel based that payment amount on what she alleged was the current value of the Property of $148,500.

One West objected to confirmation of the Original Plan on April 20, 2010; stating that, Benafel was attempting to "cram down" its secured claim in violation of § 1322(b)(2)'s prohibition on modification of loans secured by a debtor's principal residence.

The bankruptcy court conducted a hearing in which it ruled that the Plan could not be confirmed. As the court observed, confirmation of the Plan was premised on Benafel's ability to cram down the One West claim secured by the Property. Though Benafel was not residing at the Property on the date the bankruptcy petition was filed, the bankruptcy court noted that it had previously ruled that, "the appropriate time to look to ascertain the status of the loan under [§ 1322(b)(2)] is the time the borrower borrowed the money and granted the security interest to the secured creditor."

On appeal, the Bankruptcy Appellate Panel reversed the bankruptcy court. The court held that the date for determining whether real property is a chapter 13 debtor's principal residence for purposes 11 U.S.C. §1322(b)(2)'s prohibition on modification of a claim secured by the debtor's principal residence is the petition date.

While a debtor may be subject to a review to determine if renting out their primary residence on the eve of bankruptcy constitutes bad faith wherein their case can be dismissed, this case made it clear that the date to determine whether real property is a chapter 13 debtor's principal residence is the petition date.

The Law Offices of James V. Sansone assists individuals file for bankruptcy protection under the United States Bankruptcy Code. We are located in Santa Rosa, California and serve clients throughout Sonoma County, Mendocino County, and Lake County, including Santa Rosa, Petaluma, Cotati, Rohnert Park, Sebastopol, Healdsburg, Sonoma, Kenwood, Glen Ellen, Windsor, Bodega Bay, Ukiah, Willits, Clearlake, Lakeport, and Kelseyville.

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