BALLOON PAYMENTS & CHAPTER 13: TO MODIFY OR NOT TO MODIFY?
A balloon payment is a large lump sum payment required upon the termination of monthly installment payments, which may have been “interest-only” payments, in some sorts of longer term loans, such as home equity loans or other “second” mortgages.
A balloon at the end of a term of payments often allows the preliminary monthly installment payments to be charged at a lower per month rate.
However, upon completion of the term of payments, the loan is “accelerated,” meaning that the balloon balance is then owed in full—immediately.
When the balloon is part of a home equity line or mortgage, secured by a lien on the borrower’s home, a real possibility of foreclosure can result if the homeowner cannot pay the balloon payment.
CHAPTER 13 BANKRUPTCY AND LOAN “MODIFCATION”
Chapter 13 bankruptcy is a “payment plan” or “reorganization” bankruptcy.
In a Chapter 13, you repay your creditors only what you can afford to pay over a 3-5-year period of time and then discharge the unpaid balance of unsecured at the end of the process.
The Chapter 13 bankruptcy process allows you to prioritize the payment of secured debts, such as home mortgages and car loans, over unsecured debts like credit cards or medical bills.
In a Chapter 13, you can, in many cases, also “modify” the terms of your payment of secured debts.
With certain parameters, you can, in a Chapter 13 bankruptcy, adjust the interest rate attached to your secured loan repayment amount, adjust the timeframe for repayment, and even adjust the amount of principle being repaid in total.
This makes Chapter 13 a significantly more robust form of bankruptcy than a Chapter 7 bankruptcy, in which secured debts may not be modified at all.
In a Chapter 7 bankruptcy, if you owe more on, say, a boat loan than the boat securing the loan is worth, you can either surrender the boat and discharge your personal liability—or keep it and the loan as-is. (Note that there are a variety of issues related to attempting to retain a “luxury” item such as a boat in a Chapter 7 bankruptcy that are outside the scope of this topic.)
What are the limitations of this ability to modify a secured debt in Chapter 13 bankruptcy?
The extent to which you can alter a contractual interest-rate has been limited by the US Supreme Court to what is known as “Till Rate.”
Till Rate is derived from the Supreme Court case of Till v. SCS Credit Corp., which addressed just this issue.
The Court in that case determined that the appropriate rate of interest to which a secured claim may be crammed down is Prime plus the “risk value” of the case, or, typically, 1-3%.
Another limitation lies in the Chapter 13 structure itself: the maximum length of a Chapter 13 payment plan is 60 months.
Thus, if you want modify or cram down your $900,000 vacation home mortgage, you’ll need to make an enormous monthly payment plan to get that done in under 5 years.
Finally, the Bankruptcy Code forbids the modification of a claim secured only by your primary residence.
MODIFICATION OF CLAIMS SECURED BY YOUR PRINCIPAL RESIDENCE
This Code prohibition on the modification of claims secured only by our primary residence is known as the Anti-Modification Rule in Chapter 13 bankruptcy.
You can cram down or modify a rental property—but not the property you actually reside in.
However, there is an exception to this rule.
Under Section 1332(b)(c) of the US Bankruptcy Code (the Federal statute governing the bankruptcy process in the US), a loan with respect to a lien on a debtor’s primary residence for which the last payment becomes due within the 3-5-year length of a Chapter 13 plan may be “modified.”
What does that mean?
It means good news for your balloon payment.
If you have a balloon payment on a mortgage (which include home equity lines of credit) loan for your primary residence that is due or past due, you can file a Chapter 13 bankruptcy and propose to pay the loan, instead of one big lump payment, in monthly pro rata amounts over the life of the Chapter 13 plan.
When you file a Chapter 13 bankruptcy, an “automatic stay against collections” is instantly activated. This is a Federal injunction that prevents creditor from engaging in any collections activity for the duration of your Chapter 13 proceeding. It protects not only yourself but also, in a Chapter 13, any human co-debtors.
The automatic stay will prevent, from the moment you file your Chapter 13, repossessions, seizures, Michigan state court replevin actions—and foreclosures.
A mortgage with a balloon payment attached secured by your primary residence can be modified after it has matured and accelerated if you propose to pay the entirety of the amount due within the 60-month maximum length of the Chapter 13 proceeding.
Thus, if your mortgage has accelerated, leaving only, say, a $30,000 balloon payment to complete and you do not have the funds available, you can file a Chapter 13 bankruptcy to stop any threatened foreclosure and proposed to pay equal monthly installments of that $30,000 balloon over 60 months, plus interest.
The interest rate will again be the Till Rate discussed above.
Exactly what it turns out to be will a subject of discussion, negotiation, or oral argument in front of a judge between the creditor’s attorney and your own Chapter 13 bankruptcy attorney.
Balloon Payments in Chapter 13 Bankruptcy: The Bottom Line
The bottom line with regard to balloon payments is that, if you are considering filing for Chapter 13 bankruptcy because your mortgage lender is threatening or has initiated foreclosure proceedings due to an accelerated balloon payment, you must retain an experienced bankruptcy attorney to assist you.
Such payments are the result of contract, which both State and Federal law will presume that you fairly bargained your signature onto, knowing full well the consequences of the agreement.
Therefore, unless the creditor is willing to simply be nice about things, very little in US law will force them to do anything but enforce that contract other than a bankruptcy filing, and only a Chapter 13 bankruptcy can modify the terms of that contractual obligation.
Attorney Walter Metzen has represented thousands of consumers in Chapter 7 and Chapter 13 bankruptcy cases in Michigan. A Board Certified Bankruptcy Expert, Attorney Metzen has dealt with bankruptcy and foreclosure issues for over 20 years.
The Law Offices of Walter A. Metzen & Associates offers free consultations for those interested in the bankruptcy process and is experienced in determining and advising as to the best course of action when filing a Chapter 7 or Chapter 13 bankruptcy in Michigan.