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Do You Provide Hard Money Second Mortgages for Chapter 13 Bankruptcy Buyouts?

Do You Provide Hard Money Second Mortgages for Chapter 13 Bankruptcy Buyouts?

The short answer is, “No, we do not offer hard money second mortgages for Chapter 13 bankruptcy buyouts.” The long answer is more detailed, which I'll cover in the rest of this blog post, with the intent to save you time and energy — while pointing you in the right direction.  

Let’s dive into the details…

What is a Chapter 13 Bankruptcy? 

A Chapter 13 bankruptcy (BK) is a consumer bankruptcy where a debtor is behind on their debt obligations, and enters into bankruptcy to reorganize their debt payments while maintaining ownership of their assets. 

Where We See Chapter 13 Bankruptcies in Real Estate

We most often see Chapter 13 bankruptcies in real estate and mortgage lending. A homeowner falls behind on their mortgage due to death, disability, or an unforeseen emergency. They can't make a lump sum payment to bring the loan current. Their lender won't modify the mortgage, which is secured by their primary residence, and usually has a significant equity position. 

Homeowners will turn to Chapter 13 BK to bring the creditors — including for a first mortgage, auto, credit cards, medical bills, judgments, and other debts — to the table to work out a repayment plan, usually spread over five years. The debts will be considered current and in good standing by the end of the plan. 

Why People Want An Early Exit from Chapter 13 

We’ve had several financing requests over the years from homeowners who want out of their Chapter 13 plan. Below are the most common reasons why they want a hard money second mortgage to pay off their bankruptcy plan: 

  • Their income is back to pre-bankruptcy levels and they feel limited by the BK plan.
  • The real estate market is hot and they want to get in before it’s too late.
    (I always wonder what their creditors, who took a significant haircut on the debt, would have to say about their wanting to speculate on real estate prior to their debt being paid off.)
  • They want to pull money out of their house to invest in stock or cryptocurrencies.
    (We've had this once and I didn't even want to hear the reasons why "crypto is the future.") 

There have been other reasons, but these stand out as the most recent examples.  

Understanding Why Hard Money Second Mortgages Don’t Work For Chapter 13 BK Buyouts

This section will lay out specifically why it’s next to impossible to use a hard money second mortgage to pay off a Chapter 13 bankruptcy.  

Chapter 13 Bankruptcy is for Consumer Purposes

Chapter 13 bankruptcies are consumer purpose agreements on consumer debts, which are for personal or household use like primary residences, auto loans, personal credit cards, personal income taxes, personal judgments, personal medical bills, etc. 

Hard Money Lenders Rarely Do Consumer Purpose Loans

It’s rare to find a hard money lender that will do a consumer purpose loan. Hard money lending is for business purposes for real estate investors, or business owners who take out short-term financing secured by real estate, where the use of funds goes towards a business purpose. Think of a house flipper taking out a fix-and-flip loan, a home builder using a construction loan to build a spec home, or a manufacturer obtaining a $500K hard money loan to purchase new equipment for their business.

Bankruptcy Buyouts Take A Long Time to Close

Business purpose hard money loans usually close in 10-14 days. Consumer purpose hard money loans — if a person can obtain one — often close in 20-30 days. A Chapter 13 BK buyout loan will take two to three months, and sometimes longer. 

The reason it takes so long is that the bankruptcy trustee negotiates the buyout, which means terminating the repayment plan early. The trustee then goes to the creditors in the plan to get payoffs and determines any legal objections to the creditor exiting the plan early.

All the while, the hard money lender has funds sitting idle — not earning interest — as they await the trustee’s ruling. The lender must submit the loan, title and escrow paperwork to the court to help in the decision-making process.   

Hard Money Second Mortgages are Expensive 

If you can find a hard money lender willing to do a consumer purpose second mortgage and agree to wait three months for the bankruptcy trustee to grant an early termination of the plan, you’ll be looking at a hard money second mortgage that is must costlier than your bankruptcy plan. 

Here’s what a $100,000 BK plan may look like: 

  • $100,000 plan
  • 0% interest rate
  • 60-month term 
  • $1,667/mo 

Here’s what a $110,000 hard money second mortgage may look like: 

  • $110,000 loan (includes closing costs)
  • 13.00% interest rate  
  • 20-year term 
  • $1,288/mo (Only $1,237 would be applied to principal in year one — making almost no dent in the principal balance — whereas the BK plan has 0% interest and all payments go to creditors.)

Minimum Second Mortgage Loan Amounts

Many hard money lenders have minimum loan amounts. They won’t do a loan below $200,000 because it’s the same amount of work for much less pay. 

Most bankruptcy buyout loans are going to be less than $100,000, and often $50,000 or less. It will be extremely difficult to find a lender who will put in the time and submit the paperwork required by the bankruptcy trustee for a small consumer purpose second mortgage.   

Most Lenders Are One-and-Done When it Comes to BK Buyout Loans

I have a few hard money lender friends in California that attempted or closed a bankruptcy buyout loan in the past. Each has said that they’ll never do it again because it was way too much work for so little financial reward. They were burdened with a bunch of legwork for the borrower and bankruptcy trustee, all while setting funds aside for several months waiting to get approval to close. 

Conclusion 

If you’re seeking a hard money second mortgage for a Chapter 13 bankruptcy buyout — you’re in for an uphill battle. It’s a big ask, and it’s not the type of loan scenario that most hard money lenders will consider, let alone fund. The reason is that a Chapter 13 bankruptcy is a consumer purpose agreement. A hard money second mortgage to pay off a Chapter 13 would be a consumer purpose loan, which very few hard money lenders offer. If they do offer consumer purpose loans, you’ll need to find a lender that has never done a Chapter 13 buyout loan, but is open to it. As I mentioned, lenders who have attempted it rarely make that same mistake twice. 

From my perspective as a hard money lender, the path of least resistance — which I also think is the best option — is to carry out the bankruptcy plan to completion even if it's an inconvenience or blocks another real estate investment. It’s much easier to stick to the plan than try finding a hard money lender to do a second mortgage on your owner-occupied primary residence to pay off the repayment plan. 

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