When you file for Chapter 13 bankruptcy, you don't lose any of your property. Instead, you enter into a three- to five-year repayment plan to repay some or all of your debts. Once you've made all your monthly payments and completed your plan, your remaining dischargeable debts are wiped out.
Many people who are eligible to use Chapter 7 choose that option instead. Under Chapter 7, you don't have to repay any debt. However, any property that isn't exempt under your state law (or the federal exemption list, if it's available to you) can be taken by the trustee and sold, so the proceeds can be distributed among your creditors. A Chapter 7 case is typically over in four to six months. Especially if you don't own much nonexempt property, it can be a much faster, cheaper, and easier process.
The situation is different if you own rental property, however. Many filers who own rental property find that Chapter 13 is the better choice. Here's why.
Rental Property Isn't Exempt
Almost every state provides an exemption for home equity. Some allow you to exempt all of your equity; others allow you to exempt up to a set amount. However, these exemptions apply only to your residence, not to property someone else lives in. Although you may be able to use a state "wildcard" exemption (an exemption that you can apply to any property of your choosing) to protect some of your equity, these exemptions often cover only small amounts. So, if you file for Chapter 7, your rental property could be taken and sold to repay your creditors.
Chapter 7 Bankruptcy Won't Stop a Foreclosure
If you are behind on your mortgage for your rental property, Chapter 7 won't help much in the long run. Chapter 7 wipes out your personal liability to pay a debt. However, if the debt is secured by property (such as your rental property, in the case of a mortgage on that property), the creditor still has the right to take that property back. Unless you can get current on your mortgage, the creditor has the right to foreclose once your bankruptcy is over.
In Chapter 13 bankruptcy, you can include your mortgage arrearages in your repayment plan, paying off a little each month over three to five years. As long as you stay current on your regular mortgage payments going forward and make good on what you already owe through your plan, the creditor won't have any reason to foreclose. It's much easier to pay off missed mortgage payments a little at a time than to come up with the full amount you owe all at once.
You May Be Able to Cram Down Your Mortgage
If you owe more on your rental property that it is worth, you might be able to reduce what you owe on the property to its current value, using a Chapter 13 strategy called a cramdown. You can't cram down a mortgage on your residence (the home where you live). However, you may cram down a mortgage used to purchase a multiunit building or other property that is not your residence.
In a cramdown, you reduce the amount you owe to the actual value of the property at the time you file for bankruptcy. For example, if you owe $200,000 on your rental property, but it's only worth $150,000, you can reduce the loan to $150,000 if you are eligible for a cramdown.
There's a major catch, however: If you receive a cramdown, you must pay off the loan, in full, in your Chapter 13 repayment plan. Even if your original loan was a 30-year mortgage, you'll have to pay off the cramdown amount in three to five years. This makes it prohibitive for many filers to use a cramdown for rental property. Cramdowns can get complicated; if you're considering this option, you may want to speak to an attorney.