Nolo’s Bankruptcy & Foreclosure Blog

If foreclosure looms because you've missed some payments or you think you will soon, it's time to face what's probably the toughest question of the whole process: Does it make economic sense to keep throwing money into your house?

If your mortgage debt is significantly more than the value of your home -- which is becoming the norm rather than the exception -- the main question is whether the property's value will bounce back enough to give you at least a little equity in your house in the not too-distant future.

If you owe at least 25% more than the value of your house -- whatever you determine it to be -- the wise economic decision, under the present circumstances, would be to extract as much money as you can from the house now by stopping your mortgage payments and staying in the house payment-free for as long as possible, which can be as long as a year in many states.

How do I know what the market will do in the future? I don't. And I always keep in mind the advice that Mark Twain is reputed to have given a young man: "Buy land, they're not making it anymore." Also, no formula exists that can predict how soon a particular real estate bust will be over. But, while the general history of real estate booms and busts might indicate a fairly speedy recovery, history has never seen a combination of such factors as:

• the federal government takeover of the two major government housing loan entities
• the implosion of the finance industry
• a complete collapse of the residential loan market
• continued high numbers of foreclosures 
• the inability to accurately determine residential real estate values
• super-tight credit markets
• the likelihood of a deep recession, and
• tapped-out consumers who can't make good on any of their debts, mortgages included.

The fact is, there is no guarantee your house will ever recover its original value. As the old saw goes, you don't want to throw good money after bad. If the housing market fails to rebound because of these factors (and others sure to come), every economic sacrifice you make now to keep your house could be for naught if you ultimately lose it.

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.

Earlier today, I was watching the Senate Banking Committee debate the administration's proposal to have Congress write the Secretary of the Treasury a blank $700 billion check to fix the bad mortgage debt problem and other financial market woes. As Secretary Paulson was explaining the need for such awesome power, a sidebar appeared on the screen stating that Paulson's net personal worth is $500 million.

That got me to thinking: It would be very helpful for TV public affairs shows to always put up sidebars or bubbles showing the net personal worth and annual income of their various talking heads. The same would go for TV appearances by public officials, politicians, and political shills of all stripes. I found myself wondering about the Fed chairman's net worth, and then the members of the Committee and the other "experts" assembled to support the administration's request. From there, my thoughts jumped to the TV commentators and pundits who are either super rich themselves or operate in those circles.

Why should we care about someone's wealth whose views are foisted upon us 24/7? Every time one of these well-heeled folks says something being proposed is in "our" interest, I have to wonder whose interest they are talking about. Surely Secretary Paulson's interest is not the same as mine, as my net worth is slim to none. So, when Henry Paulson, or Ben Bernanke or Nancy Pelosi or Rush Limbaugh, or John McCain advises that a course of action would be in "all our interests," I'm pretty sure they're thinking of a relatively small circle of family, friends, and associates whose net worths are way up there in the many millions. There are exceptions to this class-based viewpoint of course -- Franklin Delano Roosevelt may have been one -- but for me, it holds more truth than not.

So here's what I think about the proposed bailout. It's crystal-clear that the people who have made out big time under the current credit-debt system desperately want it to continue. And for them, the bailout is a necessity. It may be that it's a necessity for the rest of us as well, but I'm unwilling to take it on trust from the people who are pushing that line.

If I had knowledge of who had most benefited from the housing and credit bubbles, I would be better positioned to assess whose interests were being served in the proposed bailout. For now, it appears to me that the "titans of Wall Street" and the government that serves them are using the same shock-and-awe approach to this power grab as has worked so well with the American people in the past -- scare the hell out of them, and then take what you like.

This, of course, implies that this was and is an engineered crisis. And why not? Everyone in a position of responsibility repeats the mantra that these high-flying finance types are very smart people. If so, they must have seen it coming. A lot of us said-to-be less brilliant people saw the handwriting on the wall a long time ago.

Of course, a possible alternative explanation is that the Masters of the Universe (to paraphrase Tom Wolfe's Bonfire of the Vanities) are far too arrogant and completely lacking in common sense. In that case, we really ought to ignore what they say and let events take their course. It's not inconcievable that "the market" will produce a better outcome. I would like to see, however, a broad-based program to help the millions of homeowners facing foreclosure, even if a larger bailout bill never makes it out of Congress.

A couple of months before the government takeover of Freddie Mac and Fannie Mae, Congress passed a new law providing financial backing for these quasi-governmental agencies, straight out of the U.S. Treasury. The fact that they have now been taken over means very little, except that a new crop of mis-managers will take over operations at somewhat lower compensation rates.

According to a plethora of financial market pundits, the takeover will "calm financial markets" and hasten the day when real estate values can be determined with some amount of certainty. As long as prices keep falling, sales will not keep up with inventory. Undoubtedly true. However, perhaps the time has come when America really is bankrupt in deed, if not in name, and it will just take a few respected leaders (possibly a presidential candidate or two) to call out the naked emperor. In the meantime, we can expect to be treated to a series of "light at the end of the tunnel" statements by the "powers that be", all designed to calm the savage consumer beast and keep the big money in America instead of some other, more financially stable, country.

Although the real estate fiasco can be hard to understand, a brilliant article in the Sunday, September 14^th San Francisco Chronicle pulls it together about as well as anybody can. The most important point in the article is that the new housing recovery law will likely only benefit the most irresponsible of the impacted homeowners -- this because of the abililty of the lenders to pick and choose which loans they will cash out at 90% of the home's current appraised value. While this approach may help the bottom lines of the various banks that got caught shorthanded, it does little for our sense of fairness. Or, to put it another way, it makes the old saw "let no good deed go unpunished" a little less funny in the case of the millions of homeowners who have struggled to stay current on their mortgages but who will now be deprived of relief because their loans aren't bad enough to justify the lender taking a hit.

The credit bubble is leaking furiously, as shown by skyrocketing foreclosure rates, but it hasn't popped yet. People keep borrowing more, and if they can't borrow on their home equity, they just run up the debt on their credit cards. And if people can't afford to pay their mortgage loans, you can bet they won't be able to pay down their credit cards, which generally have far steeper interest rates and penalties.

To borrow from Winston Churchill, it appears that foreclosures were not the beginning of the end of the credit crisis, but merely the end of the beginning.

Trends in earning, spending, and saving have pointed to a credit crisis for years. It may not end until an unprecedented wave of consumer and small business bankruptcies wipe away the debt that just can't be repaid. Personal bankruptcy rates are already rising -- there were 40% more in 2007 than in 2006, according to the American Bankruptcy Institute. There may come a day, not too far away, when millions of consumers will throw up their hands and walk away from their mountain of unsecured debt by declaring bankruptcy.

You can follow the credit bubble as it shifts and morphs its way through our financial institutions at http://www.federalreserve.gov/releases, where the Federal Reserve posts monthly reports that track the effects of the credit crisis on America's financial infrastructure.

If the flow of money is the fuel of American capitalism, then these reports are the fuel gauge. The Fed's unglamorous reports give us hard data on how much money is coursing through the American economy.

• Monthly G.19 Reports. These are the reports on consumer borrowing, both traditional loans (such as car loans) and "revolving debt," also known as credit cards. Each month, the Fed lists the total amount Americans have on our credit card bills. The amounts are staggering -- $968 billion in credit card debt, more than 7% higher than just last year -- and show no signs of shrinking. Read more at http://www.federalreserve.gov/releases/g19/.
• The "charge off" rate. This is the percent of loans, including credit card balances, that the lender has written off as uncollectible. The latest figures show that banks are giving up on 5.47% of the credit card amounts owed to them. This figure is the highest since the current bankruptcy law took effect, with the exception of a brief flurry of bankruptcies before the passage of the law. More information here: http://www.federalreserve.gov/releases/chargeoff/.
• The savings rate. This data shows how much Americans are saving each year. It's been hovering between zero and 2% for five years: http://research.stlouisfed.org/fred2/series/PSAVERT. For other Fed research data on personal spending, see http://www.bea.gov/national/index.htm#personal.
• The bankruptcy filing rate. This data is kept by the US court system, updated monthly and can be found here: http://www.uscourts.gov/bnkrpctystats/statistics.htm.

You can get other important numbers and information from non-governmental sources, including:

• RealtyTrac, which offers one-stop shopping for the latest foreclosure statistics and news: http://www.realtytrac.com/news-trends/index.html
• InsideARM.com, which offers an excellent, well-organized archive of timely articles on economic data affecting the debt and credit industry. The link below is for Credit Card news, but be sure to hover your cursor over the News & Analysis link for a list of other areas you can search: http://www.insidearm.com/go/tags/credit%20card.

An article on Newsweek's website asserts that chapter 7 bankruptcy filings are following an upward trend, with more and more people seeking bankruptcy protection, despite recent changes to the law making it more difficult to file. Readers of this blog will know that I advocate bankruptcy as a way to avoid foreclosure; according to Newsweek, filing bankruptcy to deal with an imminent foreclosure is one of the reasons for the boom:

In some cases struggling homeowners are filing to prevent foreclosure. (A record high 243,353 homes went into foreclosure in April, according to data released on May 14 by RealtyTrac.) Squeezed by rising costs for everyday necessities like gas and groceries and unable to tap into their homes for temporary relief -- declining values have left some people owing more than their homes are worth; it's also more difficult to get home equity lines of credit or loans -- many people have turned to their credit cards "as a last resort," says Robert Lawless, a professor of law at the University of Illinois who follows bankruptcy trends.

While digging the debt hole deeper seems like it might be a good idea in the short term, filing bankruptcy now will help you avoid the costly penalties that credit card companies will saddle you with as your balance goes ever-upward. If you're thinking of filing for chapter 7 bankruptcy, be sure to visit LegalConsumer.com, my co-blogger's website, to try out his free means test calculator. The calculator can quickly tell you whether you qualify for chapter 7 bankruptcy under the changes in the law that went into effect in early 2008.

On January 23, I wrote in this blog that people ought to use their rebate check to file bankruptcy. I pointed out that past attempts to stimulate the economy in this manner had pretty much failed, due to the fact that people used the money to pay down their debt, and that this time the loan sharks would gobble up most of the government's gifts hook, line, and sinker.

In an April 25, 2008 Associated Press article by Tom Raum, President Bush is reported to have said the money would help Americans cope with rising gasoline and food prices, as well as aid a slumping economy. According to the article, Sen Charles Schumer (D. N.Y) responded: "It's galling to think that taxpayers' stimulus checks will be lining the pockets of OPEC. The sad truth is that the average American family will spend almost their entire stimulus check on higher gas prices this year."

Let's say it like it is: George Bush (and, not so coincidentally, most of Congress) is giving their oil buddies a $150 billion tax rebate. It may be in your bank account for one brief moment, but it will quickly be recycled into the major oil companies' coffers. All of this takes place in the context of the worst housing slump since the depression, record foreclosure numbers, and a recession in many -- if not all -- states.

My earlier proposal makes even more sense now. It will help folks who really need help and will serve to make our economy stronger. Everyone with significant debt (which is just about everyone) should use his or her rebate 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 give you a good start on the fees, especially if you are married.

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 oil companies and 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 can't get much tighter. Anyway, it's not a bad idea for us to break our national addiction to debt and learn to pay as we go.

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.