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What is ?is?? ? Can a bankruptcy plan modify a mortgage on a house that was a Debtor?s principal residence?

By Dan Press, Virginia and D.C. Bankruptcy Attorney

It depends on what the meaning of the word ‘is’ is. If the–if he–if ‘is’ means is and never has been, that is not–that is one thing. If it means there is none, that was a completely true statement…

Testimony of William Jefferson Clinton, President of the United States, Before the Grand Jury Empaneled for Independent Counsel Kenneth Starr (August 17, 1998).

In both Chapter 11 and Chapter 13 bankruptcies, the debtor’s plan can “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.” Other than to cure defaults, a bankruptcy court is powerless to make changes to the terms of a mortgage on a debtor’s principal residence, subject to a few exceptions, including the right to strip off wholly unsecured junior mortgage liens and the right to modify loans secured by other collateral.

None of these restrictions apply to properties purchased as investment properties, or even as second homes. But often, a family will move out of their former home and rent it out rather than sell it. How does this rule apply to these properties? And can a debtor simply move out of the house on the eve of filing bankruptcy in order to modify the mortgage? These questions turn on what “is” means.

The U.S. Bankruptcy Court for the District of Columbia has joined a significant number of courts in allowing modification of a mortgage on a former residence, in this case after the debtor moved out of her residence into a rental property shortly before filing.   In re Roemer, 421 B.R. 23 (Bankr. D.D.C. 2009).  Because “is” in the Code is used in the present tense, the clear import of the language applies only where the property “is” the principal residence as of the petition date.

On the other hand, many courts have held that the purpose of this statute is to protect lenders’ in the residential mortgage market to ensure the continued flow of capital to home buyers, and thus that “is” should refer to the time the loan was originated.   But the mortgage before the D.C. court had a provision, as is standard in most residential mortgages, that the borrower would occupy the property as a residence for one year, which meant that even if “is” refers to the origination date, that provision would limit the anti-modification protection after a move-out to one year after the loan was originated.

As a result, with a little bit of planning, the debtor in the D.C. case was able to confirm a plan that modified a mortgage on her condo, just by moving out.  Certainly, for those debtors who in good faith have rented out their former homes, “is” should mean “is,” and the mortgage on the former residence should be subject to modification in Chapter 11 or 13.

Oh – and our D.C. debtor?  Three weeks after her plan was confirmed, she filed a change of address notice saying that she had moved back in.   But be careful: following that case, a Maryland debtor who was just a little less clear in showing that she had in fact moved out and changed her domicile was held to have not changed her principal residence before filing, and modification of the loan was denied.

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Full post as published by Credit Law Network on March 29, 2011 (boomark / email).