Bankruptcy

Are Chapter 13 Debt Limits Too Low?

Chapter 13 bankruptcy is especially well tailored to middle and upper middle class Americans who are having financial difficulty. In a Chapter 13 creditors get paid back at least some of what they are owed, and debtors participate in an affordable payment arrangement administered by a Chapter 13 Trustee. Chapter 13 is usually a win-win proposition, where all parties benefit.
In the midst of the current economic recession, particularly with the decline of the real estate market, Chapter 13’s are in danger of being unavailable to the people who need it the most. There are maximum debt limits imposed on potential Chapter 13 debtors. Currently, you cannot have more than $336,900 in unsecured debts or $1,010,650 in secured debts. This was well explained recently on these pages by my friend and colleague Kurt O’Keefe, from the motor city.

The rapid decline in home values, particularly in some areas of the country, is forcing some homeowners out of Chapter 13. This is because bankruptcy courts are increasingly finding that where homeowners have second or third mortgages that are totally “underwater” (when the first mortgage is owed more than the property is worth), the homeowner’s debt load is greater than the Chapter 13 debt limits. A totally underwater second or third mortgage is deemed to be unsecured, and if it, added to the other unsecured debt is over $336,900, the debtor could be found to be ineligible for a Chapter 13.

Some bankruptcy courts only consider the Chapter 13 debt limits if some party objects, while other courts take it upon themselves to determine the debtor inelegible for Chapter 13.

In a recent decision on this question, a California bankruptcy court Judge, Maureen A. Tighe stated, “The Chapter 13 debt limits are simply too low for a large number of middle class homeowners in this district, especially where home values have plummeted steeply leaving such large amounts of unsecured debt”. Judge Tighe determined that the underwater mortgage had to be considered to be unsecured, but invited the parties to appeal her ruling.

A clear fix for this problem would be for Congress simply to pass legislation which would increase the debt limits, or perhaps eliminate debt limits for Chapter 13 cases altogether. While they are at it, they should extend the ability of Chapter 13 debtors to modify mortgages that are under water, but not totally unsecured. This is now available to family farmers in Chapter 12, but is not available to non-farmer homeowners in Chapter 13.

Full post as published by Bankruptcy Law Network on January 28, 2010 (boomark / email).