Chapter 13 is this magic bankruptcy chapter that allows you to “strip” the second mortgage if it is fully unsecured and to cram down the mortgage on your second home. It is great, by the time you get out and successfully complete the plan in 3-5 years, you can get rid of a LOT of debt. There is one little catch. You can only do it if you meet the debt limitations. In California that may be harder to do than you think.

Under section 109(e) of the bankruptcy code, to be eligible for Chapter 13, debtor may not have more than: $336,900 in noncontingent, liquidated, unsecured debt;  and

$1,010,650 in noncontingent, liquidated, secured debt. Note, these debt limits are periodically increased.

That’s not a problem, you say. I only have about $90,000 on credit cards. I am way under the $336,900 limit. Oh wait. You want to count the second mortgage we will be stripping? That’s fine, too. I barely get in there, but I am ok. My second mortgage is only $230,000. What??? There is more? How much is my house worth now? Appraisal? You are going to count the unsecured portion of the first mortgage as well? We are going to have a problem…. Uh, we have a problem.

In re Groh, 2009 WL 1604974 (Bankr. S.D.Cal. 2009) and In re Estrada, Case No.: 09-00207 (Bankr.S.D.Cal) are the recent cases that came out holding that not only do you count the unsecured second mortgage to be stripped, but you also count the “unsecured” portion of the first mortgage, in addition to other debt you list on Schedule F (unsecured, non-priority debt, like credit cards and medical bills) to determine if you qualify under 109(e).

Here is a simple example. Client has a house worth $600,000. The first mortgage is $650,000 and the second mortgage is $200,000. Client has credit card and medical bills totaling $120,000.

We count: $120,000+$200,000=$320,000. Were we not required to include the unsecured portion of the first mortgage, Client would be ok to file for Chapter 13 (assuming other requirements are met). But, we add another $50,000 ($650,000 -$600,000) and now the unsecured debt, becomes $370,000.

Note: the same analysis applies if you have 2 properties. You are likely to run into a similar situation with 2 properties that are valued at less than the example, but as a result of combination, lead to same results.

What is the solution? There is no perfect solution.

1. You can try Chapter 11 (but it’s more expensive).
2. You can try to first do a Chapter 7 and get rid of the unsecured debts, but again that may make you ineligible for a Chapter 13 for a bit (or you may not qualify).
3. You can wait for property values to go up and reduce the unsecured portion. Downside is of course the uncertainty and the wait.