Many homeowners unable to pay their monthly mortgage face several difficult decisions. The options for dealing with this issue generally boil down to the following: sell, modify the mortgage, walk away, or rent the property out. In some cases renting the property to a tenant may avoid foreclosure and allow you to generate some rental income.
For mortgage and bankruptcy purposes, investment property is treated differently than a primary residence. First, rental property is not eligible for many mortgage modification programs. Additionally, rental property does not qualify for homestead exemptions under state and federal asset protection laws. Consequently, if you have equity in your property, the Chapter 7 trustee may be able to seize the property during bankruptcy and sell it to pay your outstanding debts.
If you are considerably upside down on your property, lien stripping may be an option. The federal bankruptcy laws allow lien stripping of secured property in a Chapter 13, but this process is not available to modify the first mortgage on your primary residence. Lien stripping the first mortgage of investment property is allowed. The bankruptcy court will “cram down” the amount you owe on the loan to its fair market value. A second mortgage can be entirely stripped off if it is unsecured.
To understand how this works, consider the following example:
Value of property: $330,000
First mortgage: $360,000
Second mortgage: 40,000
The second mortgage is stripped off and becomes unsecured debt, and the first mortgage is crammed down to the value of the property, $330,000. Your monthly payment will be adjusted accordingly.
Since a Chapter 7 bankruptcy is a liquidation process, and the bankruptcy court and trustee are concerned with whether there is sufficient equity in the rental property to sell and pay creditors. Otherwise the trustee will abandon any interest in the property and you can keep it subject to paying the mortgage. There is some legal basis for a Chapter 7 bankruptcy trustee to collect rents from the tenants for six months after your bankruptcy filing. However, it is questionable whether the trustee would have any right to rents after abandonment of the property.
A Chapter 13 bankruptcy is for people who have income and restructures repayment of debts over three to five years. As long as the property is able to generate income, and so long as you are able to financially maintain the property, you will be able to keep it and the income it generates.
For more information on bankruptcy, and which bankruptcy option is best for your situation, consult with an experienced bankruptcy attorney. Your attorney is able to assess your financial situation and inform you of all your legal rights and options.