Lien Stripping in Chapter 13

Chapter 13 involves the discharge of the personal obligation to pay most types of debt in exchange for the debtor’s best efforts to repay creditors over a 36 to 60 month reorganization of debt.  The duration of the reorganization plan and the amount of the monthly payments required are based on the application of a formula commonly known as the means test.

In addition to the elimination of the personal obligation to repay creditors, chapter 13 also allows homeowners to strip, or eliminate, junior liens (e.g., home equity line of credit or judgment liens) from their homes.  The end result is that the homeowner keeps the home but never has any further obligation to pay the stripped junior liens.  This lien stripping feature of bankruptcy is not available in chapter 7 cases.

To qualify for chapter 13 a homeowner must have regular income, secured debts under $1,081,400, and unsecured debts totaling less than $360,475.  And to qualify for a lien strip, the appraised value of the home must be less than what is owed on the first mortgage.

As an example of what is possible in these lien strip cases, one of my current clients is paying approximately $250 per month for 36 months, and at the end of that period she will retain all her property, be completely debt free, and only the first mortgage lien will remain.

It is crucial to consult with experienced bankruptcy counsel to ensure that the means test is properly calculated so that the lowest payment and shortest duration plan is approved.  For qualified homeowners, the attorney’s fees can be paid through the monthly plan payments (effectively coming out of what would otherwise go to the creditors of the case) so the “out-of-pocket” cost to the homeowner can be remarkably low.

Means Testing Outline

Means Testing  (Form B22A)
A.  Business vs. Consumer Debts
1.  If primarily business debt no means testing is necessary.
2.  "Primarily" means "majority."
B.  Calculate Current Monthly Income
1.  Includes all sources of income except Social Security Benefits for the six-month period ending on the last day of the month before filing.
C.  Compare Annualized Gross and  Median Family Income
1.  Means testing information available from the U.S. Trustee's Website.
2.  If debtor's annualized gross is below median income in the state the debtor resides compared to a family of the same size, no further means testing necessary.  Chapter 7 is available.
3.  Where debtor's annualized gross is above the median the consumer debtor must complete the means test to determine whether a presumption of abuse of chapter 7 arises due to the ability to repay debt.
D.  Calculate Disposable Income
  1.  Deduct categories of allowed expenses from current monthly income.
   i.  Most allowed expenses are from the IRS, but a few come from the debtor's facts.
2.  Where 60-month disposable income is less than $7,475, no further means testing is necessary.
i. A short chapter 13 or 7 is available.
3.  Where 60-month disposable income is more than $12,475, a presumption arises that the debtor would abuse chapter 7 if granted a discharge.   A 60-month chapter  13 may be required.
4.  Where 60-month disposable income is more than $7,475, but not more than $12,475, and the available disposable income is sufficient to repay 25% of the debtor's general unsecured claims, a presumption arises that the debtor would abuse chapter 7 if granted a discharge.  A 60-month chapter 13 may be required.
E.  Rebuttal of the Presumption of Abuse
1.  The burden of proof shifts to the debtor to show granting a discharge under chapter 7 would not be abusive of the Bankruptcy Code.
2.  Atypical income events may unfairly skew means testing results.
i.  Lanning:  Current Monthly Income is usually all that is required, but courts can consider known or virtually known information regarding the debtor's income or expenses.