Chapter 13 Bankruptcy and a Second Home

Keeping Investment Property in Chapter 13 Bankruptcy

In re Amos – NJ: In re Amos, 452 B.R.  886 (D.N.J. 2011), a bankruptcy case out of New Jersey, teaches us some important lessons. When you file for chapter 13 bankruptcy, keep in mind that your second home is not considered a reasonable expense.

A New Jersey Family Files for Chapter 13

That’s a lesson the Amos family learned the hard way. They lived in New Jersey but had another house in the Poconos. Their primary residence was worth $299,000 and they still owed $308,000 on their first mortgage and $35,000 on their second. The Poconos house was worth $211,000, with a mortgage of $233,000. On top of that, they had about $41,000 in credit card debt. With $576,000 in secured debt and $41,000 in unsecured debt, the Amos’s filed for bankruptcy. In re Amos, 452 B.R.  886 (D.N.J. 2011). Filing for chapter 13 bankruptcy requires submission of a chapter 13 plan to the court. This plan details your income and expenses and sets out a payment plan for the next five years. In chapter 13, you are required to pay all of your disposable income to creditors, so the issue of expenses becomes important. The Amos’s plan proposed to cure their arrearages on the first mortgage for each home. They planned to strip off their second mortgage and reclassify it as an unsecured loan and then planned not to pay anything to unsecured creditors. Needless to say, the bank holding their second mortgage was less than thrilled and filed an objection to the plan. See also: How Fast Can the Bank Foreclose in NJ?

Objections to a Chapter 13 Plan

When an unsecured claimholder objects to a chapter 13 plan, the plan must either include payment in full to the unsecured creditor or provide that all of the debtor’s disposable income be paid to unsecured creditors for the life of the plan. Id. at 889. Disposable income is calculated with a standard formula that compares your income with expenses with local norms. 11 U.S.C.A. § 707(b)(2). Some of your actual expenses are allowed, others are supplied by local standards. Based on the expenses they provided, the Amos’s actually had negative monthly income! Id. at 890. With negative monthly income, you’re not required to make plan payments to unsecured creditors. 11 U.S.C.A. § 1325(b)(1)(B). If that were the end of the discussion, the Amoses might have been able to keep both homes.

The Court Examines Expenses

Unfortunately for the Amoses, this mechanical formula “is only a starting point.” Id. at 891. First, the court looked into the deductions the Amoses were making from their monthly income. They claimed deductions for cure payments on their vacation home, or payments toward arrearages on the mortgage. The court judged this “clearly improper, as that property cannot be characterized as necessary.” Id. at 890. Then the court looked at the Amoses’ plan to continue making scheduled mortgage payments on their second home going forward. The court points out that continuing to pay for this vacation home is “neither reasonable nor necessary.” Id. at 892. So, these deductions were disallowed. However, they still had negative disposable income! Id. at 892.

The Good Faith Test

The bankruptcy court, however, had one more test – good faith. The chapter 13 plan must be filed in good faith, which is an inquiry independent of the disposable income test. 11 U.S.C.A. 1325(a)(3). In other words, a plan that passes the disposable income test but fails the test of good faith will fail overall. Amos, 452 B.R. at 893. Here, the Amoses lost the battle. They planned to discharge over $75,000 worth of debt while paying more than $2,500 monthly toward a second home; according to the court, this was obviously an “abuse of chapter 13.” Id. at 894.

Investment Property Classification Doesn't Help

The Amoses claimed their second home was an “investment property.” However, it was underwater and only earned $170 monthly in rent; the monthly association dues amounted to $125 and the mortgage was over $2,000. The court wasn’t buying this “investment property” theory. If it were an investment, any rational investor would be thrilled to rid himself of such an unprofitable venture. Id. at 894. In response to the Amoses’ plot to keep both houses and repay none of their unsecured loans, the court stated that a plan like the Amoses’ “has no place in chapter 13, which is a tool for reorganization and repayment of debts, not some byzantine sport in which debtors can reap benefits, at the expense of creditors, by successfully navigating a maze of technicalities.” Id. at 895.