What Happens to Homeowners in Bankruptcy?

Amending bankruptcy law to permit judges to modify home loans for chapter 13 debtors does not seem to be gaining traction in Congress, despite the fiasco with the bailout vote and pressure to incorporate more "Main Street" provisions. For many reasons, I remain convinced that any bailout should attempt to limit losses at the family-level, rather than addressing only the end consequences for major financial institutions. That said, does filing bankruptcy improve a family's chances of saving its home?

A new paper, The Homeownership Experience of Households in Bankruptcy, by economists Sarah Carroll and Wenli Li provides a tenative answer to this question. Before summarizing the findings, let me emphasize a few key points. The paper's sample comes from Delaware. Yup, that's it. That limits my confidence, and to their credit, the authors' confidence, about extrapolating these findings to the whole nation. Another difficulty is that the housing market has changed so rapidly that despite the authors' quick production of this study, the mortgages of today's families may look very different from those of families that filed bankruptcy in 2002. Keeping those qualifications in mind, what do Carroll & Li report on how many homeowners that file bankruptcy avoid foreclosure.

In short, five to six years after their bankruptcy filing, 72.1% of families still owned their homes. The remaining 27.9% lost their houses. I read this as cause for optimism about bankruptcy's potential as a home-saving device, although Carroll & Li find that among homeowners who entered the foreclosure process and did not file bankruptcy, even 57% of this group owned their homes and avoided foreclosure.

Carroll & Li conclude that "bankruptcy does not help homeowners", but I think their data show the opposite effect. Bankruptcy does help, but perhaps more modestly than some would have anticipated. Also ultimately retaining the home may not be the only positive outcome of bankruptcy for a homeowner.  Carroll & Li find that for those bankruptcies ending in a foreclosure sale, the bankruptcy adds about ten months to the process. This delay may be desirable if it mitigates some of the related costs of foreclosure by permitting families to locate alternate housing, even though it could reduce lenders' recoveries.

I disagree with Carroll & Li's effort to use their paper as evidence that modifying mortgages in bankruptcy would not be a substantial help for families. To me, the paper suggests the opposite, which is that bankruptcy's efficacy as a home-saving device could be improved if bankruptcy judges could, in appropriate situations, give families additional relief from their mortgage debt, such as by freezing an interest rate. Regardless of the interpretation, I think the authors would echo my hope that their paper stimulates more research on bankruptcy outcomes for homeowners.

Comments

[Noah Kidder]

Katie, I agree with you both as to the need for "Main Street" relief concurrent with, or to a point in lieu of the "bailout." Two problems I see with homeowners facing foreclosure and bankruptcy. First, as you observe, the bankruptcy court is without the power to modify the mortgage, something it can do in every other secured creditor/debtor circumstance (save the 910 car loan scenario). Second, and more problematically, many debtors punt on foreclosure defense in state court. By the time they an informed legal opinion (usually from bankruptcy counsel), it's too late. Even if they can cure, they're likely stuck with the original bargain, having waived all the defenses and counterclaims that would have been available before the final judgment of foreclosure entered.

[AMC]

Um. I don't know if the stats linked below are correct, but they show ZERO Chapter 13s filed in Delaware in 2002.

http://www.bankruptcyinformation.com/DE_stats.htm

Is the study looking only at Chapter 13s? Or is the study including Chapter 7s? If it includes Chapter 7s, that is a really high percentage of continued home ownership post-liquidation.

But it would seem to have zippity-nada to do with what is going on in the U.S. foreclosure landscape today.

The other problem with any extrapolation from the study would be that the study could not take into account the effect of the ability of debtors to save their primary residence in Chapter 13 if there was a reform bill that allowed modification to mortgages - since debtors did not have that ability during the study period.

[AMC]

Delaware is also one of 17 states with laws that allow only mortgages to secure home loans - not deeds of trust.

Mortgages require foreclosures to be filed, rather than the more truncated proceedings for deeds of trust.

Because of the ability to get property back with less formal proceedings, when given the choice by state law (or in California and Idaho, where ONLY deeds of trust are allowed) most mortgage lenders take a deed of trust rather than a mortgage.

When a deed of trust is used to secure a home loan, unless more cumbersome special procedures are followed, there is almost never a deficiency judgment entered against the debtors who lose their residence. This is one reason that folks are walking away from their homes - because they can, with no obligation to pay the deficiency, based (in most cases) on the choice made by their lender to take a deed of trust. Again, this is based - in most states - on the real estate lender's choices, both in taking the security for the loan in the form of a deed of trust, and then in not going through the procedures necessary to seek a deficiency, if such a judgment is available under state law.

In contrast, it appears (if the website information is correct) that deficiency judgments in foreclosures are available in Delaware:

http://www.foreclosure.com/statelaw_DE.html

Just another oddity that makes using Delaware as your sample for national extrapolations a questionable choice.

Sort of like using only investment real estate as your sample for estimating the "cost" of mortgage modifications in Chapter 13. In fact, a lot like that.

[Patches]

I have just a few thoughts and questions about the paper….

1. “August 2001 and August 2002 in New Castle County, Delaware”

(This is a supper small sample and it comes from Delaware of all places. I guess this is not a homestead State?)

2. “The stay can only be lifted by the court during bankruptcy or after the bankruptcy case is terminated”.

(Uhhhh. you don’t need the stay lifted if there is no bankruptcy).

3. “Chapter 7, the more frequently utilized option, discharges filers’ unsecured debt but requires them to surrender any assets that exceed state exemptions. For homeowners that have built up home equity, there is a risk that the trustee may sell the home and distribute any equity that exceeds the state homestead exemption to creditors”.

(This is not a problem that our Texas homesteaders face. Homeownership is sacrosanct here in Texas).

4. “Even homeowners with substantial equity can save their homes by making more payments to unsecured creditors instead of subjecting their houses to sale as under chapter 7”.

(In the context of a 13 here in Texas, its disposable income that determines the percentage to unsecured creditors not equity in a home that is claimed as “homestead”).

5. “Their median unsecured debt is $16,814, compared to a national median of $0 for homeowners”.

(I don’t even know what $0 means??? (sic) maybe?)

6. “Nevertheless, over 70 percent of lenders still lost money and the average loss amounts to almost 30 percent of what is owed to the mortgage lender”.

(Did they really lose money? Did they recoup from MIP?)

7. “Our analysis lends some credibility to the argument that households entering bankruptcy were highly likely to lose houses under any circumstances, including expanded opportunities to modify contracts in court. Thus, strengthening existing mechanisms to avoid foreclosure in bankruptcy, as proponents of recent legislation argue, may have a modest effect if the characteristics of bankruptcy filing homeowners under the new law are not very different from the existing ones”.

(Lets get real here, the biggest stumbling blocks at least here in this division in the Southern District of Texas are not the 30 fixed or FHA/HUD loans, it’s the 80/20s the ARMs and the combination of the two. Since we pass the mortgage payment thru the trustee, it is way more difficult to counter the effects of an upward adjusting mortgage payment when it comes to ARMs, especially if we catch it at the “teaser” rate. It’s easier to account and adjust to the upward pressure of increasing tax and insurance but becomes all but impossible when you add in the effects of an ARM. I think they touched on this a little but often we use 13 to buy a bit more time to sell if there is substantial equity in the home. Outside of Bankruptcy, I think you can shelter the proceeds for up to 6 months here in Texas. Inside of Bankruptcy you have to invest the proceeds into another homestead within the same amount of time.)

[Katie Porter]

AMC-- Some quick replies:
1) The link to the Delaware bankruptcy statistics that you provide in your comments seems to be grossly inaccurate. One can view the statistics on filings from the Administrative Office of the US Courts here, and they show a few hundred chapter 13 filings in Delaware in every quarter of 2002.
http://www.uscourts.gov/bnkrpctystats/statistics.htm#calendar
2) It is not true, at least in some states, that mortgages require foreclosure whereas deeds of trust can be foreclosed non-judicially. Some states provide by statute that whatever the law permits (judicial or non-judicial foreclosure) that mortgages and deeds of trust are treated the same.
3) Your reference criticizing Delaware as a sample seems to suggest that **I** conducted this study. I did not.

[Adam Levitin]

I want to correct something Noah Kidder wrote--bankruptcy courts can modify 910 car loans. They just cannot bifurcate the loan into a secured and unsecured component--it must all be treated as secured. So single-family principal residence mortgages really are unique.

[Judge Roy Bean]

I'm wondering if the focus on bankruptcy is misplaced.

Bankruptcy is a destructive and costly process. Even in Chapter 13 cases, the borrower is far more likely to wind up with a dismissed case than a successful discharge.

Many of the Chapter 13 cases are desperation moves to try and keep an aggressive or opportunistic servicer from foreclosing and usually only delay the process as oppose to FIXING the underlying problem: A toxic mortgage that the trustee and servicer don't have a financially-rational motive to modify.

[PSP]

If memory serves, the Standing Trustee for the Newark Vicinage in the D.N.J. calculated a number of years ago that between 25-30% of 13s resulted in a discharge. I wish I could remember whether that the percentage of 13s that were filed or confirmed.

I haven’t the faintest whether that is still true.

[Mike Dillon]

The State Foreclosure Prevention Working Group released it's latest:
http://www.illinoisattorneygeneral.gov/pressroom/2008_09/SFPWGReport3.pdf

"Analysis of Subprime Mortgage Servicing Performance"

**80%** of delinquent homeowners not getting any kind of loan workout or loss mit assistance?!?!?

Apologies in advance but I'm at the end of a short rope here. I'm looking for referrals for Chap 13 or consumer protection counsel for a friend of mine in Maine. 1st BK atty wasn't licensed to practice in the state. Screwed things up from the get go. 2nd is just letting FC mill roll over both her and her client forfeiting rights left and right. Trustee payments are being accepted while borrower payments are NOT. Payoff amount for a refi in process is being REFUSED borrower unless gag order is signed giving up any and all rights to seek future damages. There is $100k+ equity, per refi appraisal, at stake here which is why they want to FC instead of accepting five figure payoff.

If they want this signed there is obviously a reason for it. I'm at a loss on this one. Can't find a competent atty in Maine to handle this despite being a strong case. If anyone has any thoughts, please feel free to contact me directly.

[AMC]

KP -

1) Thanks for the link. The one I posted was the only one that came up when I did a quick search.

One problem I had was that I could only read the summary - clicking on the link only got me a pop up for a subscription.

I did find a direct link to the full article in pdf:

http://www.philadelphiafed.org/research-and-data/publications/working-papers/2008/wp08-14.pdf

2) States that only allow Mortgages ALL require judicial foreclosures - they don't permit non-judicial foreclosures.

States that allow both Deeds of Trust and Mortgages to secure home loans (or just Deeds of Trust) ALL permit NON-judicial foreclosures. [Although my undestanding is that it is rarely used in New York.]

States that allow both Deeds of Trust and Mortgages sometimes will allow a blurring of the two instruments, permitting the holders of Mortgages to go through non-judicial foreclosure if the Mortgage includes "power of sale" language (or the local equivalent). Again, "power of sale" in a Mortgage doesn't get you to a non-judicial foreclosure (or any actual power to sell the property) in a "Mortgages only" state.

Although it would be hard for me to document, in states where there is a choice (non-Mortgage-only states), there is a strong national tendency for home lenders to go with quicker non-judicial foreclosure remedies, rather than seeking a deficiency judgment, even if they are theoretically available.

While deficiency judgments aren't routine in all Mortgage-only states, it is far more common for them to be routine that in states that allow Deeds of Trust/non-judicial foreclosures.

Certainly, not facing a deficiency judgment (on top of losing a house) is a benefit to defaulting borrowers - as are very short statutes of limitations for collecting deficiency judgments - but it adds to the chances that a homeowners is going to just walk away from their home.

3) Nothing I wrote was addressed to you - the word "your" was not used in the singular. It was used in reference to the authors of the article.

[AMC]

Third paragraph from the end - "that" should be "than".

"While deficiency judgments aren't routine in all Mortgage-only states, it is far more common for them to be routine than in states that allow Deeds of Trust/non-judicial foreclosures."

[John Pottow]

KP -- What are the controls used between foreclosure debtors who file for bankruptcy vs. foreclosure debtors who don't? That is, presumably those in bankruptcy are in worse financial straits and so we'd expect MORE to lose their homes -- the fact that less do (absent controls) aligns me with your conclusion.

[Lafayette Colorado real estate]

Bankruptcy is a big problem of many homeowners especially when the property is involved to the problem.

-Audrey