Chapter 13 Bifurcation
A Chapter 13 bifurcation is a type of mortgage modification also known as a "cram-down" that is currently (as of 2011) not permitted in bankruptcy court for primary residences. Because of the intensity of the current housing crisis, though, some legislators have proposed modifying bankruptcy law to permit Chapter 13 bifurcations in certain cases.
Some judges have even reportedly ruled to grant Chapter 13 bifurcations to primary residences in certain Chapter 13 bankruptcy cases. Here's a closer look at what Chapter 13 bifurcation is and why bankruptcy law prohibits it.
Understanding Chapter 13 Bifurcation
Chapter 13 bifurcation, currently only permitted for real estate that is not a primary residence, works like this:
- A Chapter 13 filer has an underwater loan. Any mortgage loan for an amount greater than a home’s current market value is said to be "underwater." For a Chapter 13 bifurcation to work, a mortgage loan must be underwater.
- The bankruptcy court separates the filer's mortgage debt. Generally speaking, a bankruptcy lawyer would have to petition the court to make this move. It involves dividing the mortgage debt into two categories: first, the debt (in the amount of the house's fair market value) secured by the house; and second, the remaining (unsecured) debt in excess of the house's value.
- The court discharges the unsecured debt. Chapter 13 bankruptcy allows filers to repay secured debts with the potential to have unsecured debts discharged at the end of a case. Bifurcating the mortgage debt into secured and unsecured parts means that the court could discharge the unsecured portion at the end of the case.
Why Is Chapter 13 Bifurcation Not Permitted for Primary Residences?
In essence, Chapter 13 bifurcation offers bankruptcy courts a way to modify mortgages so that bankruptcy filers are able to pay those mortgages, stay in their homes and avoid foreclosure. But laws passed at a time when the government wanted to encourage homeownership prohibit Chapter 13 bifurcation because:
- Bifurcation permits filers to get out of mortgage loans. The unsecured debt discharged by bifurcation translates to a loss for the mortgage lender (or whoever currently owns that mortgage debt).
- Lenders keep prices low when repayment likelihood is high. When mortgages cannot be modified in bankruptcy, mortgage lenders know that they will be repaid in full for any loan they make (or that they will be able to take back the property through foreclosure if payments aren't made).
- Modifiable mortgages could translate to higher prices. Interest rates on mortgages would likely soar if lenders knew borrowers could discharge some or all of their loans in bankruptcy court. For these reasons, Chapter 13 bifurcations are not permitted on primary residences, but may be allowed on second homes or business properties.
To learn whether you might qualify for a Chapter 13 bifurcation, please take this opportunity to connect with a lawyer near you.