January 2008 Archives

January 23, 2008

Use Your Economic Stimulus Check to File Bankruptcy and Help the Economy

Just about everyone in and out of government is talking about putting cash in the hands of consumers to stimulate the economy. The only real points of disagreement seem to be which consumers and how much. The President wants to rebate taxes to the people who make enough money to pay taxes--the middle- and upper-classes, by definition. Democrats want people who are too poor to pay taxes to also get a piece of the action. The idea, of course, is that the recipients of this largess will kick-start the economy by immediately spending the money on consumer goods and services--appliances, cars, clothing, vacations.

The last time the government sent checks to people to help out the economy was in 2001, and many recipients used the money to pay down their debt and keep the collection agency wolves from their doors. This time around, the national consumer debt has more than doubled--and it is even more likely that the loan sharks will gobble up most of the government's gifts hook, line, and sinker. Maybe increasing the government debt by $100 billion in order to fatten the credit card and consumer finance companies will put some more credit in consumers' hands--just what we don't need--but if we follow President Bush's lead, the folks who own the finance industries will be the ones who ultimately benefit.

Here is a modest proposal that will help folks who really need help as well as make our economy stronger: Everyone with significant credit card debt (which is just about everyone) should use his or her check to file for bankruptcy. The entire process can cost as little as $600 for people who represent themselves (which many currently do, with paperwork help from paralegals and targeted legal advice from lawyers). And even if you choose to hire a lawyer to represent you, the proposed rebates will definitely get you started.

Bankruptcy has been around since biblical times, and has long been recognized as an important component of the capitalist economy in that it restores debtors to the consumer marketplace. Specifically, bankruptcy gets rid of credit card and most other kinds of debt (exceptions are alimony and child support; most student loans; recent taxes; and debts caused by fraudulent or willful and malicious actions). Most people are solvent for the first time in years when they emerge from bankruptcy, and once again are able purchase goods and services without going into more debt. Just imagine how the economy would hum if consumers were freed from the punishing interest rates that often creep over 30% for technical violations of credit contracts.

By filing bankruptcy, people will use their government checks to improve their own balance sheet, instead of donating their money to the fat cats who use the large credit corporations to bleed us dry. While it's true that mass bankruptcy filings would tighten rather than loosen consumer credit, it's not a bad idea for us to break our national addiction to debt and learn to pay as we go.

January 21, 2008

Amend Chapter 7 Bankruptcy Law to Allow Modifications of Mortgages

Proposals for dealing with the foreclosure crisis frequently include allowing bankruptcy judges in Chapter 13 cases to modify residential mortgages to bring them in line with the actual value of the debtors' homes, and, where appropriate, reduce the interest rate. This would often result in substantially reduced mortgage payments. At present, only non-residential mortgages can be modified in Chapter 13 bankruptcy.

While this approach to mortgage-debt relief seems helpful on the surface, it has one important flaw. A large number of people facing foreclosure are unable to propose feasible Chapter 13 plans that would be a prerequisite for the proposed relief. Proposals for mortgage debt relief in bankruptcy should include Chapter 7 bankruptcy as well as Chapter 13 bankruptcy.

It of course makes sense to use Chapter 13 as the vehicle for residential mortgage modifications -- Chapter 13 already allows for modification of other types of secured debts, and provides for amortization of mortgage arrears over the life of the plan. However, to extend the relief to the many debtors who can't use Chapter 13, Chapter 7 bankruptcy judges should also be authorized to modify mortgages and interest rates, and fold any arrearages into the newly modified mortgages. This will permit debtors to emerge from Chapter 7 with their home ownership intact, and reap the benefits of lower mortgage payments as part of their fresh start.

Not every person or family would be eligible for this relief. The bankruptcy judge would determine whether the debtor could afford the modified mortgage after bankruptcy. This determination would be based on the debtor's income, income history, and other expenses. If the judge decides that the mortgage would cause the debtor undue hardship or interfere with the debtor's fresh start, the mortgage would remain as is, and the creditor would be given a green light to proceed with the foreclosure. Importantly, this is the same procedure as is already used in in Chapter 7 "discharge hearings" when self-represented debtors seek to reaffirm car notes and other secured debts.

Perhaps using Chapter 7 as well as Chapter 13 bankruptcy for mortgage modifications doesn't go far enough. Maybe a special federal court procedure should be set up where anyone facing foreclosure can apply for relief without having to file any type of bankruptcy. There may be constitutional impediments to modifying mortgages outside of bankruptcy, but, if not, it would be wonderful to have a universal procedure for residential mortgage relief, at least from the standpoint of the millions of borrowers subject to predatory loans and flat-out unaffordable mortgages.

January 14, 2008

How Bankruptcy Can Be Used to Deal With Foreclosure, Part 2


As readers of this blog know, bankruptcy can be used to effectively deal with foreclosure. In keeping with my last post on the subject, I've just published an article in the Nolopedia, Nolo's encyclopedia of free legal information:

"If you are facing foreclosure and cannot work out a deal or other alternative with the lender, bankruptcy may help.

"If you get behind on your mortgage payments, a lender may take steps to foreclose -- that is, enforce the terms of the loan by selling the house at a public auction and taking payment of your loan out of the auction.

"This won't happen overnight. The foreclosure process typically starts after you fall behind on your payments for at least two months and often three or four. That gives you time to try some alternate measures, such as loan forbearance, a short sale, or a deed in lieu of foreclosure..."

To keep reading, click here.

January 11, 2008

How Bankruptcy Can Be Used to Deal With Foreclosure

The media is full of stories about the skyrocketing rates of foreclosure. Often, people believe they can save their home and they scramble to find the best possible way to prevent their home from being taken away. Not uncommonly, however, the handwriting is on the wall--the home will be lost--and the homeowner's chief concern is how to move on without causing further harm to his or her economic status. In either situation--keep the home or move out--bankruptcy can be an incredibly useful tool in dealing with foreclosure.

What is foreclosure? In California and most other states, a foreclosure starts when you fall behind on your payments for several months. Your lender sends you a Notice of Default giving you a period of time to cure the default--typically three months. If you haven't caught up by the end of the default period, you are notified that the property will be sold at public auction--on a date scheduled roughly 20 to 30 days later. If you still haven't adequately dealt with the problem by that date, the property is sold and you can't get it back unless your state laws provide a redemption period--one last grace period for you to recover the house by paying off the loan being foreclosed on.

Some people facing foreclosure on their home manage to work out a settlement with their lender under which the payments they've missed get tacked on to the end of the loan period. Others get their lenders to agree to a short sale--that is, you sell the property for whatever you can get for it and the lender writes off the difference between what you owe and the sale proceeds. If the loans being written off were used to acquire or improve the home, there is no income tax liability. If the loan was used for other purposes (for example, a home equity loan used to fund a vacation) then the amount written off can be considered as taxable income. See New Tax Break for People Who Default on Their Mortgages.

Bankruptcy may provide some relief. At the point you are faced with the forced sale of your property, you will undoubtedly start thinking about bankruptcy if you haven't before. Bankruptcy may help you keep your home or, if that's not in the cards, at least get you out from under your mortgage without liabliity for the deficiency (the difference between what you owe and what the property is ultimately sold for). And bankruptcy also eliminates any tax liability you might have for loans taken out against the property for purposes other than property improvement. By delaying the foreclosure process, it can also help you save some money to deal with the aftermath of your bankruptcy.

When you file bankruptcy, the foreclosure process comes to a halt (called the "automatic stay") and remains that way until your bankruptcy case comes to an end or the lender obtains court permission to proceed (called "lifting the stay").

There are two types of bankruptcy--Chapter 7 and Chapter 13.

Chapter 7 bankruptcy. Chapter 7 is the most popular type for getting rid of debts. However, a Chapter 7 bankruptcy typically lasts for only four months--after which the foreclosure can resume. And if the court grants the lender permission to continue the foreclosure while your bankruptcy case is pending, you have even less time. In short, Chapter 7 won't prevent an ultimate foreclosure--although for the time the process is delayed you can live in your home for free and amass a savings that can help you find a new dwelling.

In addition to getting rid of unsecured debt, such as credit card and medical debts, Chapter 7 bankruptcy will also get rid of your mortgage debt (and exempt you from tax liability for the loss incurred by the lender in the foreclosure sale in case the loss involved a loan that wasn't used to acquire or improve the property. As mentioned, write offs on loans used to acquire or improve a principal residence no longer generate income tax liability).

Chapter 13 bankruptcy. Chapter 13 bankruptcy is a different animal altogether. You can actually defeat the foreclosure by proposing a plan to pay off mortgage arrears over time. For example, assume you are $10,000 behind on your mortgage. You file a Chapter 13 bankruptcy and propose a plan under which you will make current paymnts on your mortgage and additionally pay off the $10,000 arrears at a rate of $277 per month over three years, thereby keeping your home and avoiding the foreclosure sale.

While Chapter 13 bankruptcy may seem like an ideal solution, you may not be able to propose or afford a plan that the court will approve. This is because certain debts such as child support and back taxes must be paid in full during the life of the plan, and you must have enough steady income to meet your daily expenses as well as the arrears and other debts you are required to pay off under your plan.

Since a repayment plan under Chapter 13 plan isn't always practical, and since Chapter 7 will only provide a temporary delay from the foreclosure sale, how should you proceed? If you come to terms with the fact that you'll have to move--a bitter result to be sure but sometimes unavoidable--you can at least view bankruptcy as the best way to get out from under your mortgage debt (and any tax liability you might have) as well as a way to save some money that will help you weather the psychological and economic shocks that lie ahead.

To read further, check out my latest article in the Nolopedia, Nolo's free encyclopedia of legal information.

January 11, 2008

New Tax Break for People Who Default on Their Mortgage

Until this year, people who defaulted on their mortgage would often get an extra kick in the teeth--a tax bill on the difference between what they owed and what the property was finally sold for. With a new federal law, Congress has changed this for the better. How the old law worked. Prior to 2007, if you owed $300,000 and your home was sold at auction for $250,000, the lender would file an IRS tax form 1099 reporting the $50,000 difference as plain old taxable income to you. Since debt forgiveness just doesn't seem like it should be taxed as income, this practice left many people fuming (or worse). Mercifully, the Internal Revenue Code allowed you to escape the tax if you could prove you were insolvent at the time or if you got rid of the debt in bankruptcy. The new law. Now, with a few exceptions, Congress has done away with this practice (in a new law, H.R. 3648), effective for the 2007 tax year and the following two years. This means that whatever happens to your home mortgage during that period will not increase your income tax. Whether the law is allowed to sunset after 2009, or whether Congress acts to make it permanent, will probably depend on just how broke the government feels at the time. What this means: more options for those losing their homes. In past blog posts, I have touted bankruptcy as a good way around the tax issue--since debt discharged in bankruptcy has never been considered to be taxable income. I explained that if you were going to lose your home anyway, bankruptcy was preferable to foreclosure or some of the other remedies such as "short sales"and "deeds in lieu of foreclosure," all of which generated taxable income. Now, if your default is on a mortgage or other debt secured by your home that is used to buy or improve your home, you can choose the best possible course of action without worrying about the tax ramifications. In some cases this will be a short sale, in others a deed in lieu of foreclosure, or if your overall debt situation warrants it, a Chapter 7 or Chapter 13 bankruptcy. Exceptions to the new law. This tax break doesn't apply to loans for real estate other than your principal residence. If you walk away from a loan on your second home in the country, for example, expect a 1099 in the mail. Similarly, if you take out a home equity loan and take that world trip you've been dreaming of for 50 years rather than use the money to improve your home, you may end up on the wrong side of a tax bill. In both of these situations, bankruptcy will still be an attractive way to avoid income tax liability.

To learn more about tax liability in short sales, see Nolo's article Short Sales and Deeds in Lieu of Foreclosure.

January 8, 2008

Corrected Bankruptcy Means Test Forms Posted on U.S. Courts Website

Update: January 15th, 2008

Be aware that many local courts are still offering the defective "original version" of the fillable .pdf means test forms, rather than the fixed "v2" versions (see below). It does not appear that the U.S. Court System has informed the lower courts that the new forms need to be posted.

I feel sorry for anyone who is trying to use them.

Original Post:
The defective means test forms that were discovered on the U.S. Courts website this weekend and mentioned in this blog two days ago were fixed this afternoon (1/8/2008).

The government quietly replaced the defective forms with ones that work. I tested them. They really do work. Woo hoo!

How can I tell if I have the fixed version of the form?

If you downloaded the January '08 means test form from the U.S. Courts before Tuesday, January 8th, you have an old form and should replace it. The old means test form (version "f") is unusable.

  • OLD = ends with the letter "f" -- > B_022A_0108f.pdf.

  • NEW = ends with the letters "v2" --> B_022A_0108v2.pdf.

Links to the revised, fixed forms:

Official U.S. Courts forms page

Chapter 7 Means Test (Form 22A)

Chapter 13 Income Statement (Form 22C)

January 6, 2008

Error Found in Government's Latest Downloadable Means Test Forms

Update: January 8, 2008

Woo hoo! The problem with the means test forms has been fixed!

But if you were unfortunate enough to have downloaded an early version of this form (before January 8th, around 3pm EST) you were probably driven crazy by the the bug described in the original post below. Relax. You're not crazy. Download the new means test forms. They work. It's all good.

Original Post:

Imagine my surprise yesterday afternoon, while checking out the new official bankruptcy means test forms for Chapter 7 (Form 22A) (.pdf) and Chapter 13 (Form 22C) (.pdf) when I discovered they don't work right. In fact, the bug in the form makes it impossible to fill out correctly.

The problem is with Lines 19A and 39 of official Chapter 7 means test form (22A), and lines 25A and 45 of the Chapter 13 form (22C).

In each case, the first of these lines is the allowance for living expenses. The second of these lines is supposed to be the excess amount of living expenses you are claiming (if any), above and beyond the amount in the first line.

The problem is, the .pdf versions of the forms put the same number in both lines. This is a mistake - the second number is supposed to be the amount in excess of the first, or zero if the actual expenses were lower than the official living allowance.

So, for example, if you switch the amount on line 39, the amount on line 19 changes, and if you go back and change line 19, the value you type also appears on line 39. (The exact same problem happens in the Chapter 13 form, with lines 25 A and 45.)

Programming bugs happen, so as soon as I discovered the problem, I promptly sent an email to The Powers That Be so they can correct it. But for now, the defective forms are still posted on the official bankruptcy forms website run by the U.S. court system.

In principle, the fact that the government is now offering fillable .pdf forms is a great thing; fillable forms make it easier for people to complete them cleanly, without a typewriter (remember those?).

Unfortunately, the current bug makes it impossible to fill out the forms accurately.

While you're waiting for the government to fix the official form, you can get an idea of how you fare under the the new means test form by going to the means test calculator I offer on my site LegalConsumer.com. The calculator has been updated for the changes that were introduced January 1, 2008.

In the meantime, be aware that you are NOT crazy. It is impossible to fill in the government's downloadable means test form correctly. And if you know someone who has downloaded the new official forms, warn them about this issue and tell them check back at the official bankruptcy forms site (or this blog) to find out if the problem has been fixed.