Ever since bankruptcy reform, Chapter 13 has become a popular choice (okay, the only alternative) for middle class debt relief. To file for Chapter 7 (liquidation), you can't earn too much, and you can't mind giving up what may be your most valuable or favorite possessions. So many folks who might have opted for a 7 in the past get funneled into Chapter 13.

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Qualifying for Chapter 13

Qualifying for Chapter 13 means having enough income to pay your priority debts (like student loans and back taxes) and your secured debts (like your mortgage, including any missed payments), and hopefully at least part of your unsecured debt. Your secured debts may be just over $1 million, and your unsecured debts are limited to about $360,000. That doesn't seem too restrictive at first glance. Unless you have an underwater mortgage.

Your poor butt has to file Chapter 11

Homeowners with property in severely depressed housing markets are discovering that bankruptcy courts consider mortgage debt that exceeds the property value to be unsecured and it can blow the filing right out of court. One construction consultant I know spent nearly three years relying on credit cards to keep the lights on (that's unemployment for self-employed people -- you work 50 hours a week and get no check!) and pay the mortgage until she couldn't make the payments any more and owed $93,000.

No problem, right? Wrong -- she is $190,000 under water on the lot and the $110,000 second mortgage on her home is also considered unsecured. The drop in housing prices means she no longer qualifies for regular bankruptcy and must consider a Chapter 11 (generally filed by high net worth folks or corporations, not people with negative net worth!). Chapter 11 bankruptcy is much more expensive and notoriously difficult to complete. It isn't limited to five years.

Even the judges don't like this. In a recent decision on this question, a California bankruptcy court Judge, Maureen A. Tighe stated, "The Chapter 13 debt limits are simply too low for a large number of middle class homeowners in this district, especially where home values have plummeted steeply leaving such large amounts of unsecured debt." Judge Tighe determined that the underwater mortgage had to be considered to be unsecured, but invited the parties to appeal her ruling.

Could this be fixed?

Sure, it could. Congress could simply (okay, they can't "simply do anything") pass legislation which would increase the debt limits or perhaps eliminate debt limits for these cases altogether. While they are at it, they should increase the trustees' ability to modify mortgages that are under water, but are not totally unsecured, turning up the heat on mortgage servicers a bit.