Archive for the ‘Credit Issues’ Category

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A Bankruptcy Doesn’t Get Rid of Your House

Monday, February 28th, 2011

I frequently talk with people who think that by filing a bankruptcy, they can rid themselves of a house they don’t want anymore. Unfortunately, this is not the case.

In the modern housing crisis, there are many people who do not want to keep an over-encumbered house. They may have lost a job and know they will never be able to pay for it, or their efforts to obtain a loan modification may have been frustrating and ineffectual, and they are just tired of fighting to keep the house. So, the logical next question is, how can I give my house back to the bank? The short answer is, you can’t . . . unless the bank agrees.

(Note: I am using the term bank here loosely. Yes, I know that almost all residential loans are handled by a servicer, not by the holder of the note.)

Often, these people need to file a bankruptcy anyway and they think that the bankruptcy can help them deal with the house they want to dump. Here comes the confusing part: they are partly right and partly wrong. The bankruptcy discharges the personal liability on the debt, i.e., the bank could not sue you and get a money judgment against you personally. However, the bankruptcy does not cause the property to be transferred from you to the bank. And this can be a big problem for several reasons.

As long as the property is in your name, you are responsible for everything that happens on the property. So, you have to keep the insurance and property taxes current, and you have to make sure that the property complies with all codes and ordinances, e.g., making sure the grass is watered. Also, if your home has a property owners’ association, you are liable for any post-petition fees or assessments. This may be why it seems like banks are slower to foreclose on houses with property owners’ associations.

So, what has to happen to have the property transferred out of your name? There are several ways that could happen when the property is “under water”:

1. Deed in lieu of foreclosure. Sometimes, the bank is willing to take a deed in lieu of foreclosure. Essentially, the borrower signs a deed to the bank. Unfortunately, the bank usually requires a laundry list of guarantees to do this, and even then, few banks will actually approve these. Banks want to get the property sold and quickly out of the bank’s name, not keep it around in the bank’s name.

2. Short sale. A short sale means selling your property for less than the bank is owed. To do that, the bank has to agree. Getting bank approval can take a long time and they may not agree to it. There are also issues with potential tax consequences from doing a short sale. Once escrow closes, the property is no longer in the borrower’s name.

3. Trustee’s Sale a.k.a. Foreclosure. The foreclosure process takes a minimum of 110 days, but usually longer. First, the bank records and sends out a Notice of Default, giving the borrower 90 days to bring the loan current. If the loan is not brought current, the bank can then give 20 days notice of a trustee’s sale. At the trustee’s sale, the property is equitably transferred to the new owner, but it is not finalized until a trustee’s deed is recorded. Usually, the trustee’s sale deed is recorded within 15 days of the trustee’s sale. It is probably not safe to consider the property to have left the borrowers name until the trustee’s deed is recorded.

In bankruptcy, we might say that the “debtor intends to surrender the house.” But all that means is that the debtor will not be contesting a foreclosure. The bank still has to complete the foreclosure for the property to be transferred out of the debtor’s name. And sometimes, it takes a long time.

I have had many clients who have told me that the bank took over 2 years to foreclose on a home. Consequently, I usually suggest that clients not move out of a home until they know the lender will foreclose. That way, the client can make sure the property is kept up and taken care of while waiting for the lender to foreclose. Of course, the client won’t have to pay any rent during that time period and can save up for moving costs.

Posted in Bankruptcy, Chapter 13, Chapter 7, Credit Issues, Foreclosure, Fresno Bankruptcy, Loan Modification, Mortgage Servicing | Comments Off

FTC Bans Upfront Fees by Debt Negotiators

Friday, July 30th, 2010

The FTC enacted a new rule, effective October 27, 2010, that will ban debt negotiators from collecting an advance fee before the debt has been negotiated.

This is a serious problem, as I have commented before on this blog. It has been said that the business of most debt negotiation companies is akin to a Ponzi scheme, because it essentially requires failure of the debt negotiation plan for the debt negotiation company to be most profitable. Most of these companies require payment of almost all of the fee upfront. So, for example, the total debt might be $40,000, monthly payment for 36 months might be $500, and the debt negotiation fee might be $4,500. But almost all of that fee would be taken in the first 9 months and then the debt negotiation would start. By that time, at least one of the creditors will have sued and the plan will fall apart. Most of the time the debtor will end up filing bankruptcy, having obtained no real benefit from the debt negotiation plan.

In addition, the rule will provide how much of the fee can be collected for each debt that is settled:

To ensure that debt relief providers do not front-load their fees if a
consumer has enrolled multiple debts in one debt relief program, the
Final Rule specifies how debt relief providers can collect their fee
for each settled debt. First, the provider’s fee for a single debt must
be in proportion to the total fee that would be charged if all of the
debts had been settled. Alternatively, if the provider bases its fee on
the percentage of what the consumer saves as result of using its
services, the percentage charged must be the same for each of the
consumer’s debts.

I do not think that the current business model used by most of the debt negotiation companies out there will work with these rules. So, we will either see a lot of companies get out of the business or they will be using a different business model, one that actually serves the clients. That being said, I would not be surprised to see a lot of companies try to operate while ignoring this rule.

Posted in Credit Issues, Debt Settlement, Fair Debt Collection, Fresno Bankruptcy | Comments Off

Debt Negotiators Coming Under Increasing (and Deserved) Heat

Monday, June 21st, 2010

We have all heard the nauseating commercials: “If you owe $10,000 or more on credit cards, you may be eligible for a special program that will allow you to settle your debt for a fraction of what you owe! For more information on settling your debt in a government bailout era, call now!”

What they don’t tell you is that they have an incredibly low success rate or the reasons for their incredibly low success rate. Here are a few:

1. They take almost all of their (unconscionably large) fee upfront. Usually, it works like this. They set you up on  a payment plan paying say, $1,000 a month (which is usually about 4 times what you could afford). They take the first 4-5 months as their initial fee. Then, they take a percentage of what comes in after that to pay out to creditors.

2. They don’t do anything until you are at least 180 days past due. At that point, creditors have either turned it over to the collection wing, turned it over to the litigation wing, or sold the debt for pennies on the dollar. Only in the latter case will a reasonable settlement be reached and usually, some creditors do one thing and others do something else. In almost every case, at least one creditor sues and tries to garnish wages or a bank account. And, the calls that debtors receive are voluminous.

3. They don’t tell you that it is entirely voluntary on the part of the creditor and if one creditor refuses to play ball, the whole thing will go up in smoke because you will get your wages or bank account garnished by that one creditor, which will make it impossible for you to make the monthly payments.

This is a really good article in the New York Times addressing a lot of these debt negotiator problems. It is pretty clear that debt negotiators have a very low success rate:

In the case of two debt settlement companies sued last year by New York
State, the attorney general alleged that no more than 1 percent of
customers gained the services promised by marketers. A Colorado
investigation came to a similar conclusion.

The industry’s own figures show that clients typically fail to secure
relief. In a survey of its members, the Association of Settlement
Companies found that three years after enrolling, only 34 percent of
customers had either completed programs or were still saving for
settlements.

“The industry is designed almost as a Ponzi scheme,”
said Scott Johnson, chief executive of US Debt Resolve, a debt
settlement company based in Dallas, which he portrays as a rare island
of integrity in a sea of shady competitors. “Consumers come into these
programs and pay thousands of dollars and then nothing happens. What
they constantly have to have is more consumers coming into the program
to come up with the money for more marketing.”

The following account is typical of what I see frequently with people who go to a debt negotiator before coming to see me:

Ms. Robertson made nine payments, according to Financial Freedom. Late
last year, a sheriff’s deputy arrived at her door with court papers:
One of her creditors, Capital One, had filed suit to collect roughly $5,000.

Panicked, she called Financial Freedom to seek guidance. “They said,
‘Oh, we don’t have any control over that, and you don’t have enough
money in your account for us to settle with them,’ ” she recalled.

Her account held only $1,470, the representative explained, though she
had by then deposited more than $3,700. Financial Freedom had taken the
rest for its administrative fees, the company confirmed. 

Bankruptcy may not be right for everyone, but debt negotiation (at least through most of the firms out there) is rarely right for anyone.

Posted in Bankruptcy, Credit Issues, Debt Settlement, Fresno Bankruptcy | Comments Off

Fresno & Clovis Home Values Levelling

Thursday, June 10th, 2010

Fresno and Clovis home values have been somewhat level for about the last year, although Fresno home values did decrease slightly during that time.

This chart from Zillow.com shows the average home price in Fresno for the last five years.

And this chart shows the average home price in Clovis for the last five years.

This is interesting for bankruptcy professionals for a few reasons:

1. If home values are levelling off, people who are buying homes right now will not be below water in 5 years and are less likely to get into troublesome loans (and there aren’t many out there anyway).
2. In the last 2 years, we have seen a lot of completely unsecured second mortgages. If home values start going back up, some of those unsecured mortgages might be start being partially secured. If that is the case, debtors would not be able to discharge the second mortgages in Chapter 13 bankruptcy.

I like to look at median household income as a basis for figuring out what home values should be. Fresno median household income is $32,236. Clovis median household income is $42,283. Generally, you don’t want to see home values at an amount that would require payments higher than 31% of the borrowers gross income. This would put the monthly mortgage payment for a Fresno borrower at $832.76 per month and for Clovis, $1,092.31 per month. Assuming 6% interest and 30 year term, this would put the maximum median loan amount for Fresno borrowers at $138,897.94 and for Clovis borrowers it would be $182,188.29. Current Fresno home values are $139,700 and for Clovis it is $211,100. According to the income analysis, that means Fresno real estate should be nearing the bottom of its free-fall and Clovis may have a bit farther to fall. We’ll see if that is the way it plays out, because there are a lot of other factors that influence real estate values. It is just my opinion that income should be the main one.

Posted in Bankruptcy, Chapter 13, Credit Issues, Fresno Bankruptcy, Lien-Stripping | Comments Off

Fresno Bee: Many Valley Homeowners Abandoning Mortgages

Tuesday, June 1st, 2010

The Fresno Bee had a nice feature article on May 8 entitled More Valley homeowners abandon mortgages. I commented on the morality of strategically defaulting here, but this Fresno Bee article addresses more of the practical issues involved and the author seems to do a good job of answering all of the common questions. One question answered is the hit on one’s credit score from a foreclosure. This is what the article said on that:

Like any foreclosure, a strategic default leaves a scar on a borrower’s credit history.

Credit
counselor Dees — whose housing counseling program is underwritten by
an assortment of federal grants and grants from banking organizations
and other industries — said many of his clients are frustrated after
their bank has denied a plea for help, especially after so much news
about bank bailouts and government programs to modify loans.

“One
of the first things we explain is that you’re not hurting the bank by
walking away,” Dees said. “You’re only putting yourself in a worse
situation.”

While still a red flag, either a short sale — in
which a bank agrees to let the owner sell the home for less than the
balance owed — or a deed in lieu of foreclosure “look more favorable
on a credit report,” Dees said. “It’s much better to work with the
lender to get it sold the right way.”

Maddux and White suggest that the effects of foreclosure are overblown.

“The
perception is grossly misrepresented,” said Maddux. “The damage isn’t
as bad as people think — it’s about 100 [to 125] points on a credit
score.”

White said most people “can expect to recover from the
negative impact of foreclosure on their credit score within a few
years.” By renting for far less, they can apply the rest of their
mortgage payment to get ahead on other bills, he said.

With the number of people defaulting, I had assumed the credit impact could not be that bad, but I had not yet seen someone take a guess as to what the average hit was.

Posted in Credit Issues, Fresno Bankruptcy, Loan Modification, Mortgage Servicing | Comments Off

Morality of Strategically Defaulting on a Mortgage

Thursday, May 6th, 2010

This is a very interesting paper on the morality of strategically defaulting on mortgage payments. The paper examines some of the common concerns expressed by borrowers as to the morality of deciding not to pay the mortgage and letting the house go to foreclosure. Concerns include (1) the fact that homeowners “promised” to pay the mortgage, (2) a feeling that homeowners should hang on to help preserve the neighborhood value, and (3) the concern that if everyone defaulted the market would collapse. The author addresses each of these concerns in turn, eventually finding that there is no moral basis to criticize homeowners who decide to let go of their homes.

I am often asked about the morality of letting a house go to foreclosure or of filing bankruptcy, for that matter. I think the author of this post has some good points. I also direct clients to the Bible. In our culture, the Bible is still considered THE primary source for foundational moral authority and it has many things to say about the debtor/creditor relationship. While there are general themes about responsibility, which by implication would require a debtor to pay his debts, the vast majority of passages on this subject are warnings to lenders not to take advantage of debtors. Following are a few examples:

Exodus 22:25 – lenders were not allowed to charge interest.
Exodus 22:26 – lender had to return security to the borrower if it was needed by the borrower.
Deuteronomy 15 – Debts were to be released every seven years.
Nehemiah 5 – Nehemiah severely rebuked the lenders because they had taken advantage of the poor.

Posted in Bankruptcy, Credit Issues, Foreclosure, Fresno Bankruptcy | 1 Comment »

Financial Reform = No More Derivative Special Treatment in Bankruptcy?

Monday, April 26th, 2010

Thomas Jackson and David Skeel have written an interesting piece in the Wall Street Journal proposing that true financial reform might be as simple as getting rid of the special treatment that derivatives are given in Bankruptcy. Derivatives are truly given special treatment in the bankruptcy code. In fact, in a recent article in the California Bankruptcy Journal, Michael Weiss suggested a way to make bankruptcy proof loans using derivatives.

This is an interesting concept and should be investigated. Unfortunately, I doubt Congress will be have the foresight, or should I say, the lack of political motivation, to examine this issue closely.

Posted in Bankruptcy Legislation, Business Bankruptcy, Chapter 11, Credit Issues | Comments Off

Recipe for Disaster: The Formula That Killed Wall Street

Tuesday, February 24th, 2009

This is a fascinating article about a formula used for measuring risk on collateralized debt obligations and credit default swaps and how the misuse of that formula led to many of the problems we are experiencing now.

Posted in Credit Issues, Mortgage Servicing | Comments Off

Why Bankruptcy Professionals Care About Credit Default Swaps

Tuesday, December 9th, 2008

This is a great article from the American Bankruptcy Institute regarding credit default swaps and why they are important to bankruptcy professionals. (Membership required to access article.)

A credit default swap (CDS) (essentially) is a contract in which the holder of the indebtedness (the creditor) pays a third party to guarantee payment of the debt. When a “credit event” occurs (e.g., default in payment), the third party is required to purchase the debt from the original creditor with a given period of time. The parties (creditor and third party) are swapping risk for return. The creditor will get less interest on the debt, but is guaranteed full payment of the principal, so the risk goes down. The third party shoulders the risk of default, but gets the increased interest to compensate for the risk.

So why does this matter in the bankruptcy arena? If a debtor calls a lender trying to workout a loan modification and the lender has a CDS on the debt, they will tell the debtor: “Why should I work out a modification with you? I’m going to get paid in full for this debt.” Now, once the debt is swapped to the third party, the third party may or may not be willing to work out a loan modification based on the reason the third party bought the CDS. However, in the confusing morass of figuring out who owns the debt and which of the possible owners might be willing to work with him, the debtor usually gets discouraged and figures there is no way to save his home.

This is yet another reason why allowing mortgages of personal residences to be modified in bankruptcy makes a great deal of sense.

Posted in Bankruptcy, Credit Issues | Comments Off

Modern Money Mechanics

Wednesday, December 3rd, 2008

Modern Money Mechanics is a workbook originally published by the Federal Reserve Bank of Chicago. (First publication in June 1961; last updated June 1992; now out of print.) This little pamphlet does a fantastic job of describing exactly how our money system works in the U.S. Most people have no clue how this works, but the effect of monetary policy on our everyday lives is a hot issue right now and for those who want to know, this is a good resource. (For a link to the PDF version of the workbook, click here.)

Particularly fascinating is the expansion and contraction of the monetary supply made possible by the fractional banking reserve system. You could end up with $90,000 worth of assets and liabilities based on $10,000 in deposits.

Posted in Credit Issues | Comments Off

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