Nolo’s Bankruptcy & Foreclosure Blog

A recent Harvard law school study indicates that healthcare costs are "behind" roughly 60% of bankruptcy filings. My personal experience gleaned from counseling close to 1,500 bankruptcy debtors since 2005 would suggest a much lower figure, at least under the commonly accepted definition of "behind," but I'm not from Harvard. To paraphrase the famous line from Wayne's World, "I'm not worthy."

But aside from that, as with all such studies, statistics can be reported in any number of creative ways. For example, according to my experience, in a typical bankruptcy case the credit card debt load alone comes in around $30,000 whereas the actual medical debt is usually less than $1,000. Does this mean that my clients' medical debt is "behind" their bankruptcies? I wouldn't think so, but add a relatively small portion of the credit card debt that may be pushing their bankruptcies, and the word "behind" becomes somewhat more credible. Still, not counting mortgages, car loans, student loans and tax debts, a large majority of the debt (in my cases at least) has come from purchases and personal loans for living necessities, family vacations, car and home maintenance, "toys" and, not insignificantly, from penalties and interest for late payments and overcharges.

Are my clients healthier than the norm? I don't think so, but almost all of them receive their primary healthcare through Medicare, Medi-Cal (a state-specific variant of the federal Medicaid program), or employment-related benefit programs. To be sure, some of them have gone without while others have been left with residual debts due to co-payments and the occasional uncovered treatment or prescription -- a relatively insignificant part of their overall debt load. There are, of course, exceptions to this -- an uncovered trip to the emergency room with a $15,000 price tag or the like has provided the bankruptcy filing trigger more than a few times.

So, if I were issuing a report based on my cases, I could honestly say that healthcare debts have been part of the mix, but I wouldn't want to insinuate that medical costs were the most important factor. Of course, since I only serve California debtors, their experience may be way different than that attributed to bankruptcy debtors in other states -- and the Harvard poll may be perfectly accurate outside of the Golden State.

Still, the timing of the report -- derived as it is from a poll taken some two years earlier -- is suspicious given the fact that the national healthcare debate is about to begin in Congress. It makes me suspect that the poll is being reported in a manner to serve an agenda -- one that is tilted towards significant healthcare reform. Simply put, someone is wagging the dog, but don't get me wrong. That's my agenda too. I just wish that polls and the statistics that are drawn from them were not so consistently used to manipulate public opinion in a particular direction rather than to tell "just the facts, ma'am" and let those who read them draw what conclusions they will. Jeez, I know, my naïveté runneth over.

In a brief article found on the Debt Law Network, the author notes:

The FTC has found that some organizations that offer debt management plans (DMPs) have deceived and defrauded consumers, and recommends that consumers check their bills to make sure that the organization fulfills its promises. If you are paying through a DMP, contact your creditors and confirm that they have accepted the proposed plan before you send any payments to the organization handling your DMP. Once the creditors have accepted the DMP, it is important to:

• Make regular, timely payments.
• Always read your monthly statements promptly to make sure your creditors are getting paid according to your plan.
• Contact the organization responsible for your DMP if you will be unable to make a scheduled payment, or if you discover that creditors are not being paid.
  

The article goes on to explain what can happen if you are late with a payment. What it doesn't say as clearly as it might, however, is that your plan will most likely go up in flames if you fall short on your payments. In my humble opinion, you should stay away from debt management plans for this reason alone. But there is more. 

First, as confirmed by the FTC, the company you choose may be a scam. In addition to not delivering on its promises, it may be taking your money under circumstances where it's clear you can't afford the plan. Second, by paying a "middle man" to do something that you could do yourself  (negotiate a payment plan with your creditors), you are wasting precious resources. And third, none of the plans that I've seen are willing to open their books and publish their success/failure ratios. Since I don't know what those ratios are, I can only guess that they would likely scare off future customers and bring the FTC down on them even faster than is already the case.

Perhaps my biggest reason for being so negative about DMPs is that they divert your income from you and your family to the DMP company and your creditors. Assume, for example, that your plan requires you to pay $300 a month for three years, and after the first year you are unable to continue making the payments. During that first year you will have paid $3,600 under your DMP for no good reason. Had you deposited that $3,600 into a savings account, you would be in much better shape to rebuild your finances.

Of course, you will still have to deal with your debt in some way. My way is bankruptcy. If you are guided by a morality that compels you to repay your debt, file under Chapter 13 and throw as much money as you can into your Chapter 13 plan. If you, like many, feel justified in getting a fresh start within several months rather than several years under a Chapter 13, file under Chapter 7. Unlike Chapter 13, you can probably handle your own Chapter 7 bankruptcy without a lawyer, which means that for several hundred dollars you can be rid of your credit card debt no matter how much you owe.

"But," I hear you say, "my credit will be ruined if I file bankruptcy." Yes it will, at least for a while, but your credit may likely already be in the tank. More importantly, in the new economy, we will all be required to live within our means. If you are able to save every penny you would use to pay off all or a major percentage of your credit card debt yourself rather than under a DMP, your savings account will be large enough to replace the financial cushion that good credit provides.

People often ask me about how Chapter 7 bankruptcy will affect their ability to keep their car. If you aren't making payments on a car, then it's just a matter of using whatever exemptions are available to keep it, just like any other asset. However, if you are making payments on your car, it's not so simple. As part of your bankruptcy you must decide how you want handle the note. You do this by filing an official form called the Statement of Intention (SOI) with your other bankruptcy papers as well as mailing a separate copy of the SOI to your lender.

If you want to walk away from the note, you list the lender on your SOI and state that you intend to surrender the vehicle -- that is, turn it in to the lender. This will clear you of any further liability on the debt after your bankruptcy. If you are leasing your car, you can get out of the lease by rejecting it on your SOI, or you can keep the car by assuming the lease. The choice is yours.

If you want to keep a car you are making payments on, the bankruptcy code gives you a choice between laying out a lump sum to purchase the car at its current value (called redemption), or entering into a new contract (called a reaffirmation agreement) which lets you keep your car under much the same terms as your original car note (although this is negotiable). In some cases, you can keep the car without entering into a reaffirmation agreement. Whether or not you have to enter into a reaffirmation agreement or can just keep making the payments -- called the ride-through option -- is up to your lender.

To find out what your lender wants, call them and ask for the bankruptcy or loss mitigation department. Explain that you intend to file for bankruptcy and ask whether you need to reaffirm the car note or whether you can retain the car and continue making payments without reaffirming. If the lender agrees to let you retain and pay, you won't owe anything on the debt after the bankruptcy but the lender will still have a lien and can repossess the car if you default on your payments.

No matter what else is going on in your bankruptcy, you should continue to make your payments as scheduled. If your lender accepts your payments, it's a sign that you will be able to retain the vehicle and continue making payments without reaffirming. Again, this is good because it means you can keep the car without worrying about any deficiency arising if the car is repossessed (or you decide to give it back) after your bankruptcy case is over. 

If the lender wants you to reaffirm, you must state on your SOI that you intend to reaffirm. The lender will send you an agreement setting out pretty much the same terms as your old agreement. As this point you should consider negotiating terms more to your advantage. You do have some leverage here in that bankruptcy gives you the option of surrendering the car and canceling all liability. Lenders lose a lot of money on repossessions and your lender may be willing to cut you a better deal, such as reducing the principal of the loan to the car's current value. Don't be afraid to attempt to negotiate. All they can say is "no."

Once you and the lender have agreed on the terms of the reaffirmation agreement, you must sign the agreement and file it with the court. A "discharge" hearing near the end of your bankruptcy will be set and the judge will decide whether the agreement should be enforced. In so deciding, the judge will consider your income, the amount you owe on the car, its value, and whether, given all these factors, the reaffirmation agreement would create an undue hardship or be against your best interests (typically because you'll continue to owe much more than the car's value).

If the judge approves the reaffirmation agreement, then you will be liable under its terms after your bankruptcy. For instance, if you owe $25,000 under the agreement and your car is only worth $10,000, you'll be on the hook for $15,000 or more should you have to give the car back due to a loss of income, and since you can't file another Chapter 7 bankruptcy for 8 years, that would truly be a debt from hell.

If the judge disapproves the agreement, according to several bankruptcy court opinions, you can keep the car as long as you remain current on your payments. These courts reason that as long as you do what is required of you by the bankruptcy code (state your intention to reaffirm, sign and file the reaffirmation agreement, and attend the discharge hearing) the fact that judge disapproves the agreement is beyond your control and should not result in your having to give up your car -- provided, of course, that you stay current on your payments. See In re Moustafi, 371 Bankruptcy Reporter 434 (Bankr Ariz 2007) (PDF).  In other words, you will be better off if the judge disapproves the agreement, since you will then have the equivalent of the ride-through option.

Sometime this week, the House is expected to vote on H.R. 1106, the bill that would allow Chapter 13 bankruptcy judges to modify residential mortgages. Right now, judges cannot modify mortgages attached to the bankruptcy filer's principal residence.

Without question, an enormous number of homeowners facing foreclosure would be able to keep their homes now and in the future if the principal owed on their mortgage could be crammed down to the home's current market value in a Chapter 13 bankruptcy (and the interest rate reduced to the bare minimum). Not only would foreclosures be avoided, but Chapter 13 itself would become much more available as a remedy, since many Chapter 13 plans fail because of the non-affordability of the filer's mortgage payments.

Previously, I've argued that Chapter 7 judges should also be allowed to modify mortgages, since so many more people file Chapter 7 than Chapter 13. However, half a loaf is better than none, and allowing Chapter 13 judges to bring mortgages into line with the value of the home would not only benefit the filer but would also provide a powerful brake on the deterioration of the residential real estate market.

You can lobby your representative by calling 1-877-354-4958 between 9AM and 6PM Eastern Standard Time only. You will be given specific suggestions for the substance of your phone conversation and prompted to enter your zip code, but the basic idea is that you favor passage of the bill.

Depending on your Congressional district, your call will be routed to the office of your Senator, your House Rep, or the White House.

In earlier blog posts, I've tried to keep up with the various foreclosure prevention programs offered by major mortgage lenders. Every major mortgage lender has some sort of policy in place to handle requests for mortgage modifications. Some polices require that you be at least three months behind on your mortgage -- Fannie Mae and Freddie Mac among them. Other lenders -- Bank of America and Indy Bank among them -- don't require that you be delinquent. Some lenders will work with you if you are in bankruptcy (FHA-insured mortgage holders among them) while others won't. Unfortunately, there is no standard, across-the-board modification policy.

As statistics mount regarding the lasting effect of modifications, it's clear that many people simply cannot afford their house, even at the level of payment provided for by the modification. In fact, according to information published by the National Association of Consumer Bankruptcy Attorneys in December 2008, payments actually increase under many modification arrangements and, overall, voluntary mortgage modification programs just don't work for a variety of reasons. A recent article in BusinessWeek makes a persuasive case that the banking industry has made the foreclosure situation worse through its lobbying efforts to stall for time in the hope that home values would recover on their own.

Many consumer-oriented commentators, including NACBA, make the case that Chapter 13 bankruptcy judges should be allowed to modify mortgages on a case-by-case basis. The Heritage Foundation, on the other hand, makes a strong argument against bankruptcy-originated mortgage modifications. While I reject much of the reasoning in the Heritage Foundation article, for reasons stated in a previous post, I don't think Chapter 13 cram-downs alone will provide much of a solution; I do think that allowing cram-downs in Chapter 7 bankruptcy would go far to prevent foreclosures.

In an article published in the New York Times on Friday February 13, Alan Zibel reports that the major mortgage owners have put a hold on foreclosure evictions, pending the much-anticipated announcement of the federal foreclosure mitigation policies. According to Zibel, Fannie Mae and Freddie Mac, JPMorgan Chase & Co., Morgan Stanley, and Bank of America Corp. have all extended non-eviction policies originally put in place shortly before Christmas until sometime in early or mid-March. Or, for some lenders, at least until President Obama announces the new federal policy -- currently expected to take place on Wednesday, February 18th.

Details of the new policy have been hard to come by in advance, except that the program is expected to cost up to 50 billion dollars and will not require that eligible homeowners be behind on their mortgages. One leak has it that the program will involve direct payments by the federal government to effect reduction of mortgage payments to 31% of the homeowners' income. The answers to the big questions -- who will be eligible for these payments and how eligibility will be determined -- are still wrapped in mystery, except that the program is expected to only apply to homeowners who have acted in good faith when acquiring their troubled mortgage. Good luck on that one. Any policy that attempts to discriminate between the deserving and the undeserving is bound to create immense resentment among those who are left out. And, at least in some cases, the resentment will be well-founded.

In a January 24th New York Times article entitled "Bankruptcy as a Step to Solvency," "Your Money" writer M.P Dunleavey quotes several bankruptcy "stars" (including Elizabeth Warren and Katherine Porter) about why people wait so long to file for bankruptcy. They point out that people suffer for an unreasonably long time under oppressive debt loads and that in many cases filing bankruptcy would restore already-trashed credit sooner than trying to rebuild the credit by avoiding bankruptcy in the first place.

All fine and good. I agree. People should file sooner rather than later, and their credit score should not hold the sway that it does. But the reason why people wait is not primarily because of credit concerns. People aren't stupid. They know their credit is in the toilet. So what's the real reason? It's primarily because attorney fees roughly doubled as a result of the 2005 changes, now in the neighborhood of $1500 and $2000 for the most basic Chapter 7 bankruptcies. In a word, bankruptcy attorneys have become unaffordable.  

This would be tragic but for the fact that there is seldom a good reason to use an attorney in a consumer Chapter 7 case. The procedures are almost exclusively administrative -- that is, there is no appearance before a judge, or any advocacy involved. The forms are all (with very few exceptions) pre-printed in plain English, intended for the bankruptcy filer's use and easily available in fillable format on the official U.S. Courts website. There are good plain English guides available, including How to File For Chapter 7 Bankruptcy written by this blog's authors, now in its 15th edition. There are plenty of bankruptcy attorneys afoot who are more than happy to provide pre-bankruptcy counseling for little or no money for people who want to check in with a professional.

What's tragic is that people think they have to have attorney representation. This belief stems in part from the fact that articles such as the one in the Times continually misrepresent the nature of Chapter 7 bankruptcy. For example, the article states: "Because bankruptcy is so complex, and because bankruptcy laws underwent a major overhaul in 2005, many people are not only wary of filing, but also confused about their options and what the possible outcomes are." People may be confused but the assertion that the confusion is justified by the complexity of the subject is flat out wrong in most cases. Yet, the exception becomes the rule, and anyone reading this article believes they can't handle their own bankruptcy. The bankruptcy bar can only smile at this intentional or unintentional piece of attorney marketing propaganda.

The article ends with a recommendation by Professor Katherine Porter that a lawyer can help you decide on the best type of bankruptcy to file (Chapter 7 or Chapter 13) and that you can find a lawyer on the website for the National Association of Consumer Bankruptcy Attorneys. And that's where the article ends. Not a word about the fact that over 20% of Chapter 7 bankruptcy filings are accomplished without a lawyer and not a peep about the resources offered by Nolo and other publishers of self-help law books.

By failing to acknowledge the possibility of self-representation and delivering its readers to attorneys they can't afford, the article becomes part of the problem. Ironically, self-representation is the one approach that may produce the very result the article recommends -- that is, get thee into a bankruptcy court sooner rather than later.

Throughout the mortgage meltdown crisis, many democrats and bankruptcy professionals have favored a change in the bankruptcy laws to allow Chapter 13 bankruptcy judges to modify residential mortgages -- something they can't presently do. Legislation to this effect was originally introduced in mid-2008, but failed because of staunch opposition by the mortgage and banking industries.

The legislation has been reintroduced in both houses of Congress (SB 61 and HR 200) and is expected to pass this time around (in modified form), due to the severity of the foreclosure crisis, the change in administrations, and, most recently, the support of a major bank. Last week, the Wall Street Journal reported that Citibank had broken ranks with the Mortgage Bankers Assocation and is supporting the new legislation -- provided that homeowners be required to seek a voluntary modification first. As with other legislation regarding bankruptcy and foreclosure prevention, its highly probable that this proposed legislation will change in many respects prior to its final passage.  

As I've pointed out in earlier posts on this subject, I'm not against the concept of mortgage modifications in bankruptcy. I am, however, concerned that the Chapter 13 remedy for foreclosure prevention is limited to a relatively small number of would-be filers due to Chapter 13 eligibility requirements, and the associated legal costs consisting of fees that can reach upwards of $3,000. Keep in mind also that over 2/3 of Chapter 13 bankruptcies fail and are either dismissed or converted to Chapter 7 -- although it's sometimes possible to modify the plan or obtain what's known as a hardship discharge. Most importantly, modifications initially obtained in a Chapter 13 bankruptcy may no longer apply if the plan fails.

In short, I think the Chapter 13 remedy is being over-hyped as a solution to the foreclosure crisis. Of course, less plans will fail if mortgage payments are reduced, but there is no way to tell what effect -- if any -- the reductions will have on the success of Chapter 13 plans overall. Another less-heralded part of the proposed legislation should add to the success of Chapter 13 plans -- under the legislation, mortgage payments are to be made directly to the lender by the homeowner. This is very important because many Chapter 13 trustees currently require payments to be made as part of the plan, which entitles them to a 10% commission on all mortgage payments over the life of the plan. This extra amount often makes Chapter 13 plans unaffordable for many would-be filers. For example, 36 monthly mortgage payments of $2,000 payable through the plan would generate a trustee's fee of $7,200, whereas no fee would be generated if under the direct payment requirement, so filers will save some serious cash.

To address the shortcomings of Chapter 13, the mortgage modification remedy should be extended to Chapter 7 bankruptcies. Like Chapter 13, Chapter 7 has a system for assessing the current value of personal property and reducing the obligations accordingly. This same system could be used to assign a current value to homes and both reduce the mortgage to that value and reduce the interest rate to the current prime rate, plus a point (the going formula for assigning interest rates in bankruptcy).

Simply put, Chapter 7 bankruptcy is far less expensive than Chapter 13 bankruptcy and is far more available to the millions of homeowners who may be in need of relief to prevent a foreclosure from occurring.

In an earlier post I warned that filing bankruptcy might make it more difficult to obtain a mortgage modification from Countrywide or other lenders while you are under the jurisdiction of the bankruptcy court. I suggested that it might be a good idea to hold off on filing bankruptcy if at all possible until you see whether a foreclosure workout with your lender is possible.

On October 17, however, in a letter to all mortgage lenders who hold FHA-insured loans (HUD Mortagee Letter 2008-32), the Department of Housing and Urban Development has made it clear that loss-mitigation efforts should move forward despite the fact that the mortgagor is in bankruptcy.

While the HUD letter doesn't constrain holders of non-FHA insured mortgages such as Bank of America/Countrywide, these and other lenders will often follow HUD policies, making it likely that you won't miss out on a mortgage modification opportunity if you decide that filing bankruptcy is in your best interest.

Of course, it would make sense for you to contact your lender to see whether it will be following this new HUD policy or whether your bankruptcy will take you out of the running for a mortgage modification. It also makes sense for you to check with a HUD-certified housing counselor by calling 1-888-995-HOPE.

A reviewer of my new foreclosure book took me to task for underestimating how difficult it had become to file a Chapter 7 bankruptcy under the 2005 bankruptcy legislation. Many people have this misconception. It's true that bankruptcy became more expensive, if you use an attorney -- attorney fees doubled under the new law in many parts of the country. And it's also true that there are a few additional hoops to jump through. However, self-help is a reasonable option for most bankruptcy filers and the new hoops are easily navigated.

Probably the biggest misconception is that many people are barred from Chapter 7 because their income is too high. The new bankruptcy law did make filing more difficult for people whose incomes exceeded the median income for their state, but only between 5% and 10% of would-be filers face this problem. All the others slide easily under the median income bar.

The new bankruptcy law did make it more difficult to get rid of some types of debts -- private commercial loans, recent credit card charges, and debts incurred in a divorce or separation decree -- but the vast majority of debts that could be discharged under the old law can continue to be discharged under the new law, including credit card and medical debt, deficiencies from foreclosures and repossessions, and bank loans.

Under the new law, filers have to undergo two mandatory counseling sessions -- one before and one after filing -- but these have not proven to be a barrier to filing, at least after an initial confusion due to ignorance of the new law. Also, the new law requires some additional documentation, such as tax returns, wage stubs, or bank records, but once again, virtually all filers can handle these items.

There are many things to consider when deciding whether to file bankruptcy, but you should not be misled into believing that it is no longer feasible. For almost all filers, the new bankruptcy is very much like the old bankruptcy -- an essentially administrative process in which you disclose information, appear for one brief meeting with the trustee, and wait for your discharge papers to arrive in the mail 60 days later.

On October 6, it was announced that Countrywide Financial has agreed to the largest program ever to modify (reduce) the principal and interest of home loans as part of a lawsuit settlement with officials in 11 states. This was followed several days later by the passage of the federal bailout bill, which contains language likely to also result in widespread loan modifications. In other words, if you have defaulted on your mortgage, or are likely to default in the near future, help may be on the way.

This raises an interesting question for homeowners who are contemplating filing bankruptcy: What effect will bankruptcy have on a homeowner's ability to participate in a lender's home loan modification program? While only time will tell for sure, here are two important points to consider.

First, when you file a Chapter 7 bankruptcy (the most common kind), the title to your home technically passes to your bankruptcy estate and is "owned" by the bankruptcy trustee -- the official appointed to handle your case. Countrywide is telling its homeowners that it won't consider them eligible for a modification while a Chapter 7 bankruptcy case is pending. So filing bankruptcy might take you out of the action just at the wrong time.

Even more problematic, a Chapter 7 bankruptcy typically cancels the promissory note portion of your mortgage along with your other debt. However, even if you don't owe anything on the mortgage itself, the lender will still have a lien on the property in the amount of the mortgage, and will be entitled to foreclose on that lien. In other words, even though you don't owe anything on the mortgage after bankruptcy, you'll still have to pay on it if you want to keep your house. Confusing? You betcha.

So, what's my point? If you don't owe anything on your house after your mortgage, you won't have a mortgage to modify, and it's unlikely that the new programs will offer modifications for liens remaining after bankruptcy. The only way to avoid this result is to offer to reaffirm the mortgage as part of your bankruptcy case (that is, agree to a new mortgage) and hope the lender agrees. As part of this process you can attempt to negotiate different terms for the new mortgage that would be similar to what you would otherwise get outside of the bankruptcy process.

Bankruptcy used to be a really good remedy for people facing foreclosure. However, in the brave new world of mass mortgage modifications, bankruptcy may foreclose your ability to partake of the manna from heaven pouring forth from our nation's mortgage lenders. For this reason, if you think you might qualify to have your mortgage modified, either by Countrywide or by your lender, strongly consider holding off on your Chapter 7 bankruptcy until you know which way the mortgage modification winds are blowing. For more information on whether you might qualify to have your mortgage modified, find a non-profit HUD-certified housing counselor by calling 1 888 995-HOPE.