More on Divorce and Bankruptcy: How do Child Support, Spousal Support (Alimony / Maintenance) and Property Settlements Impact either Chapter 7 or Chapter 13 Bankruptcy?

How certain payments owed under a divorce or family law decree—including child support, spousal support (also called maintenance or alimony) and even property settlements or cash equalizers— may impact your bankruptcy filing depends on whether you are the recipient such payments or the obligator of such payments, i.e., the payer.

For a recipient of child support, spousal support or other domestic support obligations (also called “DSO”), this support income must be added to all other sources of income in order to determine whether one is eligible to file chapter 7 under the means test. Generally speaking, if one’s total annual income from all sources including domestic support income is less than the median income for your state and household size, you will qualify for chapter 7. However if you are above the median income, you are instead steered toward filing chapter 13 with some exceptions. Median income varies by state and household size and is regularly updated. Especially if you are ‘on the line’ of the median income or above it, it is the initial job of any bankruptcy attorney to calculate the means test and advise on eligibility for chapter 7 under current median income standards.

For the payer of domestic support obligations, such support payments are typically allowed as an expense on the means test which effectively reduces one’s annual income. This means that if your regular wage or self-employment income is above the median income for your state and household size but the subtraction of domestic support payments brings you back down below the median income, then you would qualify for chapter 7 bankruptcy. Qualification for chapter 7 via this route is also called “rebutting the presumption of abuse” on the means test. However if one’s income is such that the subtraction of DSO payments does not reduce the income below the median or alternatively if one is not actually making the required DSO payments, then they may not qualify for chapter 7 and instead file chapter 13.

The means test involves various additional factors other than income and domestic support payments. For more information about median income and the means test, see What is the “Means Test” and Why Does it Matter in Bankruptcy? and 2014 Median Income in Minnesota.

Regarding property settlements (also sometimes referred to as equalization payments or cash equalizers), these are usually ordered in a divorce based on a fair distribution of marital assets rather than a need for financial support by one spouse. For example, a wife may be ordered to pay a property settlement to her ex to “equalize” her award of a family home having equity that was built up during the marriage. In this case, the wife that keeps the family home may be required to pay her ex-spouse one half of the home equity by a certain future date. Property settlements also commonly arise when one spouse is assuming most or all of joint debts acquired during the marriage and the other spouse emerges from divorce debt free other than the obligation to pay the property settlement. In any event, unpaid property settlements and cash equalizations are valuable assets that must be listed in the bankruptcy case of the recipient.

As with all assets, any individual bankruptcy debtor is limited as to the total value of assets which may be exempt and it’s possible that a portion of a large unpaid property settlement (above approx. $12,000) could be non-exempt if the recipient files bankruptcy. In this case, the non-exempt portion of the property settlement would become property of the bankruptcy estate and either liquidated in chapter 7 or, in chapter 13, at least the equivalent of the non-exempt portion must be paid into the plan. This situation is also circumstance dependent and may be affected by the facts of one’s situation, including whether the obligator spouse has a practical ability to pay the settlement.

For the payer of the property settlement, this award is a liability that must be listed in the creditor schedules. Unlike most debts, one’s liability to pay a property settlement is not usually discharged in chapter 7 bankruptcy however may be discharged under some circumstances in chapter 13 bankruptcy.

A qualified bankruptcy attorney will explain more how a property settlement would be treated under your specific circumstances, the chapter of bankruptcy you file and local bankruptcy law. For more information on how property settlements are treated in chapter 13, see Bankruptcy and Divorce: Some Payments in a Divorce Decree May be Dischargeable in Chapter 13.

Also read more about family law and timing considerations in bankruptcy: Bankruptcy and Divorce: What Should Come First?

Located in Edina, Minnesota, attorney Lynn Wartchow represents clients in all chapters of bankruptcy in Minneapolis, St. Paul, Ramsey and Hennepin County, and throughout Minnesota. Contact for a free consultation.

What are the Options for a Home Mortgage in Bankruptcy: Can I Strip a Second Mortgage in Bankruptcy or Chapter 13?

The answer is that it depends. If you file chapter 7 bankruptcy, you cannot restructure, or “strip”, any mortgage yet the underlying note is still discharged in chapter 7 bankruptcy. However, a discharge of the second mortgage does not mean that the mortgage itself is released and many debtors nevertheless continue to make the regular monthly payments on the discharged second mortgage to avoid foreclosure or to allow for a sale of the home. A discharge of the note merely means that the bank cannot collect against a homeowner personally after the bankruptcy (via a lawsuit or otherwise) yet the bank can still foreclose the collateral or demand payment of the unpaid balance in order for the property to transfer to a buyer. Therefore a chapter 7 discharge offers little benefit to a homeowner, particularly when the second mortgage is at least partially secured by equity in the property beyond the balance owed on the first mortgage.

However there are viable and beneficial options regarding a second home mortgage (or third mortgage or other junior lien) in chapter 13 bankruptcy. There are generally two options in chapter 13 bankruptcy regarding a second mortgage on a homestead property: 1) Lien strip an entirely unsecured second/junior mortgage, or 2) Cramdown the balance of a “short term” mortgage, which essentially bifurcates that mortgage into a secured portion which must be paid off during the life of a chapter 13 plan and an unsecured portion which is dischargeable at the end of the chapter 13 plan. Each option is further explained below.

Option #1: Chapter 13 Lien Strip when 2nd mortgage is entirely unsecured:

If the second mortgage is entirely unsecured—i.e., the balance owed on the first mortgage plus any other senior liens exceeds the value of the home so that there is no equity which secures/collateralizes the second mortgage—this junior mortgage may be stripped from the property. This process is called a “chapter 13 lien strip” and can only be obtained in chapter 13 bankruptcy. A chapter 13 lien strip typically requires that a recent appraisal be done which proves that the value of the house is less than the amount owed on the first mortgage. In Minnesota, a motion to determine value of the secured claim must be filed in the bankruptcy court shortly after the chapter 13 case is filed. The mortgagee-bank will have the opportunity to object to the lien strip, usually on the basis that the debtor’s appraisal is too low and that there is equity which at least partially secures the second mortgage so that it cannot be stripped under the law. However if no objection is filed or the bankruptcy judge finds that the value of the home is such that the second mortgage is entirely unsecured, the mortgage will be stripped from the property at the successful completion of all payments due under the chapter 13 plan.

Option #2: Chapter 13 Cramdown of ‘Short Term’ 2nd Mortgage:

If option #1 does not apply because there is some equity which at least partially secures the second mortgage, a chapter 13 debtor may still have an option to “cram down” the balance of the second mortgage. In this option, the balance of the second mortgage is effectively reduced to the amount of equity in the property which secures that mortgage. A chapter 13 cramdown can only be done if the second mortgage is “short term” under the Bankruptcy Code, i.e., the mortgage either has become due prior to filing bankruptcy or will become due during the 5-year chapter 13 plan. This option will not apply if the second mortgage does not become due until after the 5-year chapter 13 plan ends, i.e., the mortgage is not “short term”. Assuming the second mortgage is short term, section 1322(c)(2) of the Bankruptcy Code provides for the mortgage to be bifurcated into two parts: 1) a secured claim which must be paid off in full, through the chapter 13 plan in no more than five years and at a low interest rate; and 2) an unsecured claim which, like all other unsecured creditors, is typically repaid a fractional dividend of the total amount of the claim and the balance of the claim is then dischargeable at the end of the chapter 13 plan.  Depending on the amount of equity which secures the second mortgage and the potential savings on lowering the contract interest rate to perhaps 4% or 5%, a chapter 13 cramdown can be greatly advantageous and offer a vehicle to pay off a second mortgage for less than owed. This option is also particularly appealing for homeowners whose short term mortgages have already ballooned or soon will balloon and the homeowner is unable to pay off the amount due or otherwise refinance under favorable terms.

For more information about the advantages of chapter 13 bankruptcy, keep reading Chapter 13: Not Always a Gloomy Diagnosis in Bankruptcy.

Attorney Lynn Wartchow can help you determine whether Chapter 7 or Chapter 13 best fits your needs regarding a mortgage. Contact Lynn for a free consultation and more information on options available under either Chapter 7 or Chapter 13 bankruptcy.