I. How to Treat Repayment of Unsecured Debts (Not Secured on Property)
First, the primary purpose of Chapter 7 is to eliminate and get rid of your debts.
The primary purpose of Chapter 11 is to reorganize your debts; in other words you keep most of your debts but you put them into a framework that is affordable by Court Order.
In Chapter 7, you merely get rid of the credit card or unsecured debts that you have. The point here is that you never have to see these debts again or pay these debts again.
In Chapter 11, the theory is different. Let’s say that you may have an unsecured credit card with a balance of $20,000. You may also have a 2nd loan of $250,000. secured on a real property that doesn’t have any equity to support it. In other words, your property is worth $500,000., but you have a 2nd loan that kicks in at $525,000. I therefore apply to the Court for an Order that this 2nd loan is no longer secured on your property. It becomes a completely unsecured debt–really like an unsecured credit card–and you pay off this debt in many instances for just pennies on the dollar.
Depending upon your gross income, I may be able to get the Court to Order that you have to pay just 5 cents on the dollar over 60 months at 0% interest. For the $450,000. total in unsecured debt, you will have to pay only $22,500. over 60 months for $375./month.
So, that’s essentially the difference between treatment of an unsecured debt in Chapter 7 and an unsecured debt in Chapter 11. You see–the Chapter 7 debt goes away while the Chapter 11 debt remains but may be repaid at a very low amount..
Even though the Chapter 11 debt here is not altogether eliminated, it is now reduced to the point that it can be repaid in an affordable fashion.
II. How To Treat Repayment of Secured Debt on Your Personal Residence
A common fact for both types of bankruptcy is that the amount of the secured 1st loan (and any other purchase loan) on the borrower’s principal mortgage cannot be reduced–if there is any equity to support that loan.
Here’s an example: Your personal residence has a fair market value of $800,000.
Example #1 Your 1st loan is $600,000. and your 2nd loan is $300,000.
Under either Chapter 7 or Chapter 11, the 2nd loan cannot be reduced from $300,000. to $200,000. to match the value of $800,000. because there is $200,000. of equity to support that 2nd loan.
Example #2 Your 1st loan is $850,000.
Again, since this loan is secured on your principal residence, you can’t reduce that loan by 50,000. since there is an equity of $800,000. to support that 1st loan.
With Chapter 11, a borrower can strip the 2nd right off his/her personal residence where there is no equity to support it. Then the 2nd will become an unsecured debt.
In sharp contrast, with Chapter 7, a borrower cannot strip the 2nd off his/her personal residence even there is no equity to support it. This is another tough disadvantage of a Chapter 7 bankruptcy.
The treatment of payments of secured debt is also quite a bit different between Chapter 7 and Chapter 11 case.
One fact that people often get wrong is that they can’t keep their home or personal residence in a Chapter 7 bankruptcy.
*You can keep your home in a Chapter 7 Bankruptcy if you are current on the mortgage.
If you are behind in the mortgage, however, there is no structure in a Chapter 7 to make monthly payments to catch up. If you’re behind in the mortgage, the lender will ask the Court to allow a foreclosure if it doesn’t want to make some direct deal with the owner.
On the other hand, it is common for people who file Chapter 11 to be behind in their mortgage payments on their homes. Typically, depending upon their income, the owner will make a deal with the bank to make the scheduled mortgage payments but then pay the “arrearages” (past due mortgage payments) over a minimum of 60 months at 0% interest. Further, there is no rule that the arrearages can’t be paid back over a longer period of time, sometimes quite a bit longer than 60 months.
III. How to Treat Secured Debt on a Rental or Business Property
In Chapter 7, you can keep a rental or business property where you are current on the mortgage. BUT you cannot reduce the amount of the loan even if there is no equity to support it. In fact, even where you have a 2nd loan secured on your personal residence and there is no equity to support that 2nd loan, you can’t strip off that 2nd on your residence.
In sharp contrast, in Chapter 11, where either the 1st loan or the 2nd loan has no equity to support it, that loan or loan amount can be stripped from the property. This can greatly reduce the monthly payments for the newly reduced mortgages. Here are a couple of examples:
Example #1 On your commercial office building, your 1st loan balance is $1.4 million while the true current fair market value is $950,000.
In this instance, your 1st loan can be reduced by Court Order from $1.4 million to $950,000. and the $450,000. balance will become an unsecured debt to be repaid sometimes as low as 5 cents on the dollar ($22,500.) over 60 months at 0% interest ($375./month).
Your new 1st loan of $950,000. can also be repaid at some commercially acceptable rate of interest and the repayment period can be increased to as high as 40 years…typically 10 to 25 years.
Example #2 On this same building, your 1st loan balance is $1.5 million while your property’s current market value is $1.0 million.
In this instance, your 1st loan balance may be reduced by Court Order to $1.0 million and the remaining $500,000. will become an unsecured debt to be repaid sometimes as low as 5 cents on the dollar ($25,000.) over 60 months at 0% interest ($417./month). You may also be able to reduce the interest rate on the new 1st loan balance and extend the repayment period, subject to negotiation with the bank.
More important information is being provided in subsequent areas of this website. Feel free to contact me for a free 1/2 hour consultation. Chapter 7 or Chapter 11 may be perfect for you. Thank You