In a nutshell, an Arizona bankruptcy court has no jurisdiction to modify a mortgage that is wholly or partially secured by a primary residence. In 2009, Congress tried to amend the Bankruptcy Code to permit courts to do this, but the amendments failed to pass the House of Representatives. For example, if you have a $300,000 first position mortgage on your house that is worth $200,000, a bankruptcy court cannot force the lender to give you a new loan for $200,000 or change your interest rate. On a side note, if a foreclosure actually occurred in Arizona, the lender could not sue you for the additional $100,000 deficiency that you owe so long as the Arizona anti-deficiency statute applies. For more information about the Arizona anti-deficiency statute, click here.
Lien Strip
There is hope. If you file a Chapter 13 bankruptcy in Arizona, you may be able to completely “lien strip” junior mortgages if the home is worth less than the first mortgage. For example, if you have a first mortgage for $300,000 and a second mortgage for $50,000 and the home is worth $200,000, you could completely strip away the $50,000 second mortgage in a Chapter 13 bankruptcy. Why? Because the $50,000 second mortgage lender is essentially unsecured. In other words, if a foreclosure occurred, the second mortgage lender would not receive any portion of the $200,000 foreclosure proceeds (since the lender in first position would receive all such value). If the house was worth $310,000, a second mortgage lien strip could not occur in a Chapter 13 because the second mortgage lender would receive $10,000 if a foreclosure occurred (after the first lender received the $300,000).
An experienced Arizona bankruptcy lawyer will file the appropriate paperwork to completely lien strip the $50,000 mortgage. The second mortgage lender would be required to record a release of its $50,000 lien with the Arizona county recorder’s office at the time you finish making all of your Chapter 13 plan payments. Why is this huge? If you can get rid of the $50,000 mortgage, then you can stop paying the junior lender. Before the lien strip, the house was $150,000 underwater. After the lien strip, the house is only $100,000 underwater. And hopefully the home will start appreciating while you are in your Chapter 13 (if we cross our fingers and pray long enough).
Note that lien stripping is only possible in a Chapter 13 bankruptcy. It isn’t available in the more affordable Chapter 7 bankruptcy. For more information on the differences between Chapter 7 and Chapter 13, click here.
Modifying Mortgages for Investment Properties
Remember that a bankruptcy court cannot be compelled to force a mortgage lender to change the terms of a loan secured by your Arizona primary residence. If you have investment property (including residential rentals), then an Arizona bankruptcy lawyer may be able to “cram down” the loan to the value of the property. But there is a problem that may make this “unrealistic” for most debtors. If you have a $400,000 loan for your rental property that is worth $100,000, you can change the loan to $100,000, but you have to pay off the entire $100,000 within five years of filing the Chapter 13. This would require some kind of balloon payment towards the end of the plan term (i.e., the debtor would have to obtain refinancing or sell the property sometime during that five-year period). And you have to get the Chapter 13 trustee here in Arizona to agree to all of this, which may be difficult for a number of reasons. If you file a personal Chapter 11 bankruptcy in Arizona, you may have more than five years to pay off the new $100,000 loan, but a Chapter 11 requires a debtor to have significant and consistent income and it’s extremely expensive and complicated.
The bottom line is don’t file a bankruptcy for the purpose of forcing your home lender to give you a modification. If you or your Arizona real estate lawyer can negotiate a modification that makes sense to you, then that’s great. But nothing in the Bankruptcy Code can force the lender to do it.