Secured loan from mother - how to handle in a bankruptcy

[Slingerland]

Good morning! It's been a couple of months since I posted, but I still read daily. At the time, I had regular employment, plus cash flow positive rental properties, but high debt from my wife's medical bills. An unexpected bonus from my employer had given me the cash to weather a storm of unexpected repairs and bills.

So fast forward. I'm still doing okay, and hopefully able to avoid a C-13 filing. But I have a situation and I would like to ask a couple of questions, please.

My mother has offered to loan me 20,000 dollars to recapitalize my rentals (my cash reserves are growing, but right now are still scary and low.) The terms are 3.75% interest, 10 year payback. The loan note is to be notarized and secured by an interest in one of my houses (she likes this particular house very much.)

Thinking ahead... if everything goes to Hades again, how do I protect her in a bankruptcy?

The note is secured against one of the houses, so I'm thinking that it is treated like any other secured debt: paid during the plan like a mortgage. But there is already a first mortgage on the property... would the trustee wipe out my mother's interest in the property? (The two loans together are still less than the value of the house.)

Arkansas law doesn't require a lien be filed against the property, but I'm wondering if I should do so anyway in case of trustee questions about the validity of the loan.

Any thoughts about this situation?

Thanks!

[Flamingo]

In a situation such as this you should consult with a real estate attorney and a BK attorney as to your question about your mother's loan to you - you cannot base a bankruptcy filing on events that have not yet taken place...so much can change as to one's situation, property values may continue to fall or could rise steeply over the coming years and who knows what can happen as to your finances. Your mother should also be in on those consultations as she is taking a risk if you plan to file bankruptcy in the future...

[OhioFiler]

I would think an insider transaction of that nature would cause big problems down the road if you are forced into a bankruptcy.

[justbroke]

My only concern echoes what Flamingo wrote. I'm concerned about the perfection of the security interest and what position she holds in relation to other liens.

Arkansas law doesn't require a lien be filed against the property, but I'm wondering if I should do so anyway in case of trustee questions about the validity of the loan.

This is the most scary statement here and gives me great pause. There are just too many issues with title and liens that make Trustees go goo-goo. I mean, Trustees love lien and title issues since real property is a great source for a lot of money in a Chapter 7 liquidation. In a Chapter 13, you still need to "pass" the Chapter 7 liquidation test, meaning that the liens could STILL cause you problems in a Chapter 13.

I see that this particular property is encumbered by another mortgage in the FIRST position. Additionally, you would still have equity! This can be problematic in your Chapter 13 since you still need to perform a theoretical liquidation of the property to find out what you MUST pay in the Chapter 13.

I would seriously consult with a real estate attorney, bankruptcy attorney, and/or an asset protection attorney at this point.

[Slingerland]

Sorry about the delay in replying, long day at the day job. I did speak with an attorney back in April, he is familiar with bankruptcies and small businesses, including rentals.

Some details and background. I have professional employment and make too much to qualify for a C-7. I have 6 rental houses, all of which cash flow decently well. The past year saw unexpected repairs (2 HVACs and a roof) that drained my reserves, plus significant medical bills for my wife (cancer, now in remission.) If a bankruptcy is necessary, it is my intention to keep the rentals through the C-13 process.

Even though all of them cash flow positively (rent is 35% free cash flow over PITI), 5 of the 6 are at break-even with the mortages. Once real estate commissions, cleaning charges, evictions, trustee fes, etc are included, these 5 properties are upside down.

The 6th property is not my "normal" rental: it's literally next door to my own house. My mother is getting older and as the only child, I bought this house in case she should even need to move where I can care for her. The house is in a good part of town and even with the housing downturn, has some equity. My own house is flat with no equity... so I can use part of the federal bankruptcy homestead exemption to shield my equity in the 6th house.

In discussing with my attorney earlier this year, he indicated the trustee has no interest in taking or selling the properties. At that time my mother was offering to loan the money, and my attorney said it would be best to let her offer a secured mortage on the 6th property. That would eliminate any remaining equity position and might allow me to pay her back during the bankruptcy period.

The most important thing to me is that the trustee accept any such loan as genuine. As Flamingo and Ohio mention, it's an family loan. So I'm thinking that making the loan, notarizing a mortgage and filing a lien against the house should be enough to demonstrate it is legitimate.

As I mention, I think I can avoid filing the C-13 altogether. But if my wife's health turns sour again, or I have to replace any more HVACs, life will get "interesting" and I want to be prepared.

[Flamingo]

Is your mother aware that she could be part of a Chapter 13 filing and that discussions have taken place as to that? At this point in time, it seems you are at an uncertain stage as to where things can turn...if you are anticipating financial problems in the near future, you should sit down with some financial planners or accountants, figure out your best options and maybe sell off some of your assets/rentals if they are starting to drain you and save what you can to put you in a better place and avoid the worry of having to file. It seems at this point you are not insolvent and can prevent things from going downhill but seem to me uncertain as to what you want to do and could end up involving your mother in a Chapter 13 as having a mortgage on one of your rental houses. If this information arises during any "look back" period prior to any filing (i.e., can go anywhere from six months to two years or more) it could pose a problem. It never hurts to get some consultations with different attorneys as to your possible future situation. Best of luck to you...