Nolo’s Bankruptcy & Foreclosure Blog

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.

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.

If you want help in filing your bankruptcy, you can use a lawyer or a non-lawyer. The lawyer will charge you about $1200-$2000, depending on the location. The non-lawyer will charge you about 10% of the lawyer's fees -- between $125 and $200. So why would you use a lawyer instead of a non-lawyer? To begin, the non-lawyer can prepare your formal paperwork as well as a lawyer could -- in fact, most lawyers rely on non-lawyers to do all the paperwork.

The lawyer can counsel you about your various options, whereas the non-lawyer is prohibited from giving you any information about bankruptcy. That alone is a big reason to hire a lawyer, especially since bankruptcy laws prohibit non-lawyers from advising you about:

• whether to file bankruptcy


• which type of bankruptcy to file


• which types of debts bankruptcy will get rid of


• which types of property you can hold on to


• the tax consequences of a bankruptcy discharge


• what you should do about collateral for secured debts


• how to characterize the nature of your interests in property, or


• bankruptcy procedures or rights.

How to get bankruptcy information. So where would you get this information if the non-lawyer can't give it to you? Nolo's bankruptcy books are a good start, as is your favorite search engine. The federal court website has a publication -- Bankruptcy Basics -- that may answer some of your questions. Nolo's online Bankruptcy Resource Center has articles and FAQs about both Chapter 7 and Chapter 13 bankruptcy. The Legal Consumer website will help you with the means test (if you need it), as well as other useful information

Free legal consultations and flat-rate services. Many bankruptcy lawyers will give you a free consultation, which can be helpful if you have specific questions (for example, what will happen to your boat if you decide to file). Also, Affordable Attorney Advice offers a flat rate service of $100 for anyone using Nolo's book How to File for Chapter 7 Bankruptcy, or a California non-lawyer to do their bankruptcy paperwork.

The creditors' meeting -- do you need a lawyer? If you spring for the $1500 (average) for a lawyer, he or she can accompany you at the one personal appearance you are likely to make -- the creditors meeting. You must represent yourself at that appearance if you use the non-lawyer for your paperwork. Self-representation at the creditors' meeting is unlikely to have much of an adverse effect; however, it is you who must answer any questions directed your way in the creditors' meeting, and not the attorney who is representing you. Many believe that the fees charged by an attorney for an appearance at the creditors' meeting are a waste of money. You shouldn't really blame it on the attorney, however, since most bankruptcy judges require the appearance as an ethical responsibility

After the creditors' meeting. In most bankruptcy cases, nothing of consequence happens after the creditors' meeting. You have to file a single page (form 23) that tells the court you've completed budget counseling, and that's about it. Sixty days after the creditors' meeting, you should receive a notice of discharge in the mail. You may be curious about what this notice means and can ask your attorney -- if you have one -- or consult the resources mentioned earlier.

So why pay an attorney $1200--$2000 instead of a non-lawyer $125-$200? Beats me. If something weird happens in the case, you'll probably need a lawyer, but you can pick one up at that time. There's no point in worrying about the unexpected in advance.

Legal restrictions on non-lawyers. You may be curious about why non-lawyers are so restricted in what they can tell their customers if the type of advice people are seeking is so easy to find on the Internet. About twenty years ago, the attorneys who competed (and still compete) with non-lawyers lobbied Congress to pass the Bankruptcy Petition Preparer statute, which forbade the "practice of law" by these non-lawyers, as well as capping their fees at an impossibly low level. The intent of the statute was to drive the non-lawyers out of business -- and many turned their lights off.

For further help understanding bankruptcy, see Nolo's The New Bankruptcy: Will It Work for You?, by Attorney Stephen R. Elias.

In 2005, the bankruptcy laws underwent massive changes at the behest of the banks and credit card companies. In advance of the new law's taking effect, the nation's bankruptcy attorneys launched a scare campaign directed at potential filers. The message was, "You better do it now because it will be too late once the legislation kicks in."

Beaucoup bucks flowed to the lawyers. When the new law finally arrived, the public perception was that the bankruptcy safety net was gone forever. Not true. Chapter 7 bankruptcy is alive and well; it's only the attorneys who are suffering because they doubled their fees and nobody can afford them anymore.

In a recent interview with Lisa Scherzer on Smartmoney.com, Henry Somer, President of the National Association of Consumer Bankruptcy Attorneys, said that bankruptcy was no longer an available remedy for most people due to doubled attorneys fees and increased complexity. While it's true that bankruptcy attorneys have priced themselves out of the market, the supposed reason for doing that--added complexity--is horsepuckey. It's just as easy to get rid of debt such as credit card and medical bills under the new law as the old. And, most bankruptcies still are procedurally very straightforward. Somer, however, clearly believes you need an attorney to file bankruptcy, and if you can't afford one, oh well.

Apparently Somer hasn't heard of self-representation or non-lawyer assistance with bankruptcy forms--both of which are perfectly legal. Or maybe he has, but takes the prototypical lawyer position that doing your own bankruptcy is like doing your own brain surgery. Jeez, self-help law has been around for 35 years at least, but you would never know it from the Somer interview. There is help out there for folks who need bankruptcy but can't afford a lawyer.

A bankruptcy petition preparer (a non-lawyer) can prepare your petition for you for about $150. It's true that non-lawyers can't provide legal advice--or alert you to a problem with your petition --but there's nothing to stop bankruptcy lawyers from giving the public a break and providing the necessary legal information while letting the non-lawyers fill in the forms. For example, people doing their own bankruptcies can get all the legal help they need from me for a flat rate of $100. In this manner, self-represented filers can proceed in an informed manner with the help of an attorney and a forms expert (bankruptcy petition preparer)--and pay less than 25% of what they would pay an attorney for full representation.

Future blogs will cover such bankruptcy-related issues as:

• best practices for people doing their own bankruptcies


• why the new bankruptcy laws don't work


• how bankruptcy can be used to stave off foreclosures


• why Chapter 13 is only for people who think they'll go to heaven if they repay their debt, and


• turf wars over non-lawyer bankruptcy form preparation services.

For more information about Chapter 7 bankruptcy and your options, take a look at How to File for Chapter 7 Bankruptcy, by Attorneys Stephen R. Elias, Albin Renauer, and Robin Leonard (Nolo).

An article entitled "Prisoners of Debt," by Robert Berner and Brian Grow, published in BusinessWeek, November 12, 2007, reports that the credit reporting bureaus and large creditors systematically violate the most important of all federal bankruptcy court orders; that is, you can't try to collect a debt that has been discharged in bankruptcy.

Debts are eternal. Thanks to the "great computer in the sky," debts don't go away anymore. They may grow old and be barred by statutes of limitation--laws that prevent stale claims from being litigated. They may have been paid up but not taken off the computer. And, they may have even been discharged in a federal bankruptcy proceeding. No matter. According to the BusinessWeek article, old and discharged debts alike are bundled together and sold to collection firms for pennies (or even parts of pennies) on the dollar. These collection firms then cast a wide net to collect these debts, often through economic intimidation or threats of ruining your credit.

Reporting bogus debts is extortion. Who among us hasn't suddenly received a bill in the mail from someone who we paid years ago, alleging that we still owe the debt plus umpteen dollars worth of interest and collection fees and that our credit will be ruined if we don't pay up. Often, bogus debts first come to light when people enter into transactions that require good credit right then and there--such as the purchase of a car or obtain a loan on a house. The bogus debts are paid off in a hurry to facilitate the transaction. Using the common meaning of the word, this is extortion pure and simple.

Credit bureaus willfully refuse to update reports. While this debt-collection-by-ambush can be avoided by incessant checking of one's credit report, many people have better things to do with their time and money, especially when they have no reason to think that anything is wrong. People who thought they got rid of their debts in bankruptcy are even more discombobulated, if that is possible, when bogus debts show up on their credit report. Even when the credit-reporting bureaus are informed about the bankruptcy, they often refuse to update the report to show that the debt has been discharged.

Remedy for victims of discharge violations. The remedy available to victims of federal bankruptcy discharge violators is to reopen the bankruptcy case and sue the violators to collect damages--and even fines if they can prove the errors were knowingly made. Needless to say, the companies defend on the basis that it was simple error. It can take some serious lawyering to overcome this defense.

Victims need a lawyer to recover for discharge violations. The main message I got from the BusinessWeek article was that, surprise surprise, you have to hire a lawyer to secure what rights you thought you had when you received your bankruptcy discharge. Most people who have recently gone through bankruptcy aren't in a position to pay a lawyer--even though attorneys' fees can be recovered if they are successful. In other words, even though you can do your own bankruptcy, you'll still have to pay a lawyer to get what's yours--a fresh start.

Intentional discharge violations should be crimes. If justice prevailed over big bucks, violations of the bankruptcy discharge would be crimes, punishable by truly large fines and even imprisonment of a company's CEO if a policy of reporting discharged debts were shown to exist--as is alleged in the BusinessWeek article. This type of behavior is, after all, garden-variety fraud. But, as we all know, financial theft isn't treated the same way as shoplifting. Wonder why? Anyway, let's not hold our breath on this one.

Procedures to invoke court remedies should be simplified. At the very least, the procedures for bringing the discharge violators into court to account for their debt collection practices can and should be greatly simplified to eliminate the need for a lawyer, at least in most cases. To ease the burden on the self-represented litigant, any reporting of a debt discharged in bankruptcy should be presumed to be willful, placing the burden on the credit reporting bureau to show that they made an innocent mistake. If the burden of proof is shifted in this manner, most credit bureaus will quickly act to correct their mistakes, innocent or not. In any event, a statutory fine of $1000 should be imposed on the bureau, innocent mistake or not.

For more information on this topic, check out a new article in the Nolopedia, "Time-Barred Debts: When Collectors Cannot Sue You For Unpaid Debts", as well Credit Repair, by Attorney Robin Leonard (Nolo), now in its 8th edition.