Saturday, November 21, 2009

Rent Out Your House and Get the Ability to Modify Your Mortgages in Chapter 13 or 11 ??

Contrary to some logic, owners of investment properties have more rights to modify their mortgages in a chapter 13 and 11 bankruptcy reorganization case than do homeowners.

Due to the economic crisis, some Florida homeowners have begun to move out of their homes and rent them out to reduce expenses. The renting out of one's principal residence may have a significant benefit under chapter 13 or 11 bankruptcy -- the much sought ability to "cram down" one's mortgages.

Mortgages secured only by a principal residences are protected from modification in chapter 13 and 11 (wholly unsecured second mortgages though may be avoided), but mortgages on investment property may be modified by reducing their principal down to the present value of the real estate. The interest rate and term of the mortgages may also be modified. In short, once the property is no longer a "principal residence" -- the mortgages may be "modified."

The renting out of one's home before filing for bankruptcy may be sufficient to constitute a change in status from "principal residence" to non-principal residence. There may be arguments though that this is not sufficient. The change in status would certainly have to be in "good faith" and not a sham to be accepted by a bankruptcy court.

It would seem, though, that homeowners have a strong argument that they have the right to rent out their homes and convert them into a status of non-principal residence as most standard mortgages contain a provision that requires homeowners to maintain the property as their principal residence only for a certain short period of time. Paragraph six of a typical Fannie Mae mortgage only provides that the homeowner shall "continue to occupy the Property as Borrower's principal residence for at least one year after the date of occupancy..." Indeed even this one year period may be waived by the mortgage company's consent or if there are extenuating circumstances. In short, the ability to convert from usage as a principal residence to to a non-principal residence was contemplated and provided for in the original mortgage agreement.

The ability to modify a mortgage under chapter 13 gives one broad powers -- the mortgage payoff may be "bi-furcated" into "secured" and "unsecured" portions. The unsecured portion would be provided for with the other unsecured claims such as credit cards. Unsecured claims typically receive only a small percentage dividend in a chapter 13 plan. For example, if the payoff on the mortgage is $400,000.00 and the value is $150,000.00, the mortgage company would have a $150,000.00 secured claim and a $250,000.00 unsecured claim.

One issue would be how to provide for the portion that is secured claim. Some mortgage companies simply agree to a reduction in monthly principal and interest payments based on the reamortization over the original term based on the reduced secured claim. Others may insist on the "maintenance" of the originally monthly payment which was computed on the full payoff. This would result in the now reduced mortgage being paid off in a shorter period of time.

The media continues to report that "Florida Still Leads in Foreclosures" and that few homeowners are receiving trial modification under the administration's HAMP program and even fewer permanent modifications. Perhaps, the rental of one's property and change in status to non-principal residence may be of use to obtain mortgage modifications and help save homes.

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