–Philip van Doorn, bank analyst at TheStreet
Despite the apparent economic improvement, with the unemployment rate finally moving below 9% in November, millions will still face the possibility of losing their home through foreclosure in 2012.
While it’s not a “magic bullet” that can discharge a first mortgage loan on your residence, filing for bankruptcy can buy you some time,force a mortgage lender or servicer to negotiate with you and eliminate a significant portion of other unsecured debt, depending on your circumstances.
According to regulatory data provided by SNL Financial, the “big four” U.S. banks had huge amounts of one-to-four family residential loans on their balance sheets and serviced for others, for which the underlying homes were in the midst of the foreclosure process as of Sept. 30:
- Bank of America (BAC) had $23.0 billion in residential mortgage loans on its balance sheet with homes in foreclosure, while loans serviced for others in foreclosure totaled a whopping $90.6 billion.
- for JPMorgan Chase (JPM), residential mortgage loans in foreclosure totaled $28.9 billion, while loans serviced for others in foreclosure totaled $54.7 billion.
- For Wells Fargo (WFC), one-to-four family mortgage loans on the balance sheet with collateral homes in some phase of foreclosure totaled $18.1 billion, while loans serviced for others in foreclosure totaled $37.7 billion.
- Citigroup (C) reported $6.9 billion in residential mortgage loans in foreclosure on the balance sheet, and $10.3 billion serviced for others that were in foreclosure.
While President Obama’s expansion of the Home Affordable Refinance Program, or HARP, will allow millions of borrowers with mortgage loans held by Fannie Mae (FNMA) and Freddie Mac (FMCC) to refinance their entire balances at today’s low rates — even if the borrowers owe significantly more than the homes are worth — HARP is only available to borrowers who have been current on their loans over the past six months, and the Fannie/Freddie loans only represent about half of U.S. mortgages.
Filing for bankruptcy, of course, can’t be taken lightly, and you will need the help of an attorney.
According to Geoff Walsh, a staff attorney with the National Consumer Law Center, “the first threshold question that people need to consider when they’re looking at bankruptcy as an option for foreclosure is whether all of their major assets are covered by state exemption laws.”
For example, in New York $100,000 in home equity is exempt if you go through bankruptcy. This means that if the difference between the market value of your home and the outstanding liens on your home is less than $100,000, you will emerge from bankruptcy still owning your home. If you have more than $100,000 in home equity, the bankruptcy trustee will sell the home, give you $100,000, and pay the rest to the mortgage lien holder.
This underlines the importance of hiring an attorney. “There are some people who can really be hurt if they file for bankruptcy without properly (researching) what the exemptions are,” says Ward.
Chapter 7 Bankruptcy
According to Ward, a Chapter 7 filing “doesn’t help if the lender has a lien on an asset,” such as a house or a car, since the lien allows the lender to take back the collateral and the Chapter 7 filing “does not get rid of line or security interests.”
A Chapter 7 filing is a liquidation bankruptcy, where the court-appointed trustee sells nonexempt assets to generate cash to pay creditors a portion of what they are owed. According to Ward, most Chapter 7 filings are “no asset Chapter 7 cases,” where “all the consumer assets are exempt and there’s no distribution to creditors.” The consumer has to fill out schedules listing their assets, which the creditors are allowed to reviews.
If you file for Chapter 7 while your home is in foreclosure, the mortgage lien holder can either wait for the bankruptcy process to be completed — since there is a stay on foreclosure activity during the bankruptcy process — or since the bankruptcy doesn’t discharge the lien on the property, the lien-holder can ask the bankruptcy court to allow the foreclosure to proceed.
Generally speaking, the best you’ll get out of chapter 7, as it relates to staying in your home, is a delay of several months.
Chapter 13 Bankruptcy
According to Ward, “debtors in chap 13 have more options to deal with secured creditors than they do in Chapter 7,” because the debtor files a “Chapter 13 plan” to reorganize their finances and “define how they will handle all of their creditors over a three to five year period.”
A borrower in Chapter 13 can typically “cure a default in their mortgage” for example, by proposing to pay “an extra amount each month that could be applied to whatever arrearage that’s owed the day they file.” Of course, this assumes that after the borrower discharges a good portion of their unsecured debt through bankruptcy, that they will have sufficient income to pay more to the mortgage lender.
But if you are having difficulty communicating with your loan servicer — which has been a common complaint through the credit crisis, leading in part to the regulatory cease and desist orders against the largest national mortgage servicers — Chapter 13 can lead to a court-supervised loan modification.
Another Chapter 13 advantage for borrowers facing foreclosure is that although you can’t reduce the balance of a first-lien mortgage loan, if the value of the property has declined so that there’s no equity left for a second lien holder, “the second mortgage is not considered secured by the home,” and can be fully discharged, according to Ward.
Of course, if you are declaring bankruptcy, it is likely that you have other unsecured debt, such as credit card loans, which will also be fully discharged for a relatively small percentage of what is owed, allowing you to keep your home and emerge from bankruptcy with what Ward calls a “relatively clean slate.”
Once again, don’t take bankruptcy lightly, and make sure you hire a reputable attorney. The National Consumer Law Center says that consumers need to “watch out for bankruptcy-related scams,” and that some people and companies “advertise help with foreclosure when all they really do is put you into bankruptcy without providing any advice on how this will help or assistance in getting through the process.”
Federal law requires that consumers go through budget and credit counseling from an approved counseling agency within 180 days before you file for bankruptcy. You can find an approved counseling agency — along with a lot of other very useful information — at usdoj.gov/ust.