Home ownership is an integral part of the American psyche and the American dream. That dream became a reality for many, many new home buyers in the early and middle parts of the last decade. Now it has become their nightmare. Everyone knows the statistics or has heard them enough to be numbed to them. The perfect storm of dropping home values, adjustable-rate mortgages (which all adjusted up), and the disappearance of most major lenders have sent the housing industry into a severe downward spiral. Is the end in sight? A Congressional Oversight Panel estimates that 13 million homes will go through foreclosure in 2012.
What about the Home Affordable Modification Program (HAMP)—the $50 billion, federally funded relief for distressed home owners? The initial indications are not encouraging. The same panel indicates that less than 800,000 homes will be saved by this Treasury Department program. If you have dealt with a client who is attempting a home modification, you know firsthand how infuriating this process can be. Trying to talk to one of the remaining national mortgage vendors is a very frustrating exercise, to say the least.
I am a sole practitioner who focuses primarily on consumer and small business bankruptcy matters. But I do also undertake debt workout cases from clients seeking to stay out of bankruptcy. I recently got involved with a client who received his 60-day foreclosure notice (part of the new Tennessee foreclosure protection law). The bottom of the letter contained the hopeful language “you may also be eligible for certain federal loan modifications (sic) programs.” So I called the loan company on behalf of my client. The loan company is one of the large national mortgage companies.
I first was told the company did not have the proper authorization to talk to me. Fair enough; I had a power of attorney ready to fax. I asked for the number and faxed it immediately. I called the next day and waited for 13 minutes and 45 seconds (I timed it) while the customer service representative looked for the fax. She found it but said it was not in the system and to give her a half-hour to enter it. She would not give me her name or a way to reach her directly. I called back two hours later. The woman I spoke to said the company did not have authority, had no clue whom I had talked to, and furthermore had no idea where that fax number came from and why in the world I would have faxed it there.
She gave me two different fax numbers and said to wait five business days before calling back. One of the fax numbers turned out to be a non-working number. Even though I had the emotional detachment of it not being my house, I still was ready to staple my hand repeatedly at the end of this.
Let’s just say it is not surprising that the HAMP program is not exactly the rousing success originally predicted. Countless times I have counseled home owners filling out the massive number of modification forms sent to them and jumping through every hoop thrown their way, only to find that the mortgage company was still in the process of foreclosing while evaluating their modification application. I have had clients who received foreclosure notices and modification approvals literally on the same day. The first wave of class actions over wrongful foreclosures is now being initiated. Attorneys general in all 50 states announced on October 13, 2010, that investigations were being launched into foreclosure documentation issues. I predict the next wave will be class actions based on these HAMP problems.
But how do such investigations and class actions help the non–class action attorney (such as me) deal with people on a case-by-case basis? How can you advise the home-distressed client? When potential clients come to you to save their home, save their credit, or save their paycheck from garnishment, what options do they, and you, have?
Take a good look at your client’s overall financial situation. The home is almost always the biggest asset and the biggest debt. But is the client having other financial issues? It is a very good idea to make sure you have the entire financial picture before deciding on a course of action. It is of little use for clients to marshal whatever remaining assets they may have to salvage the house or to settle a debt with the mortgage company only to have their car repossessed or get sued on a medical bill or have their bank account drained by the Internal Revensue Service. Quite often people will make the mortgage payment at the expense of their other creditors.
It is time to have a really hard, frank talk with them. Can they afford this house? Is it in their best interest to keep it? Americans are so emotionally invested in the idea of home ownership that having this conversation with your clients can be difficult, especially for those first-time home buyers who took advantage of the Fannie Mae and Freddie Mac feeding frenzy of the 2000s. Many of them know they probably should not have gotten the loan in the first place, and the chances of getting another one anytime in the foreseeable future are bleak at best. So they want to hold onto their homes like grim death. But often it is simply not in their best interest to do that.
With the flood of foreclosures, rental houses are readily available now. The value of homes keeps dropping. Some economists are now stating that home ownership is no longer a universally smart investment. Even when home modifications are successful, consumers rarely realize a huge drop in payments. And although interest rate, terms, and duration all matter in modifications, the only thing that most consumers truly care about modifying is the monthly payment. Is saving $175 a month going to make that big a difference?
2. Decision Time
Now it is time for the critical decision: Keep the old homestead or let it go? This decision is often the critical factor in deciding between Chapter 13 or Chapter 7 for my consumer bankruptcy clients (only below-median-income clients, of course . . . in case the U.S. trustee from my district is reading this). I often tell my clients this is the cornerstone decision. My legal advice will flow based on whether they want to keep the house or not.
3. Know the Law
Be sure you are up to date on your state’s law. If your client is already behind on the mortgage, check your state’s foreclosure laws. Tennessee is a non-judicial foreclosure state. The trustee from the deed of trust may foreclose on the courthouse steps after a series of publications; no judicial action is required. Most states, however, have new legislation. In Tennessee, a new foreclosure act was enacted last fall. Lenders now have to give a 60-day notice letter before they commence foreclosure. Previously, no notice was required other than the publication of the sale. Home owners now have more time. Many major lenders have put the brakes completely on foreclosures at the moment. (New federal legislation recently was enacted protecting tenants who rent property that went through foreclosure; they have added rights as well.)
Knowing how much time you have gives you a chance to explore multiple options. If a client comes to you on the eve of foreclosure, bankruptcy is often the only option. The filing of any type of bankruptcy for an individual (Chapters 7, 11, 12, 13) will stop a foreclosure proceeding. Sometimes, however, the relief from foreclosure would be temporary at best. Before advising any distressed home owner, be sure you are familiar with all bankruptcy options. I am constantly amazed at how few lawyers, let alone non-lawyers, know what happens in a bankruptcy.
Chapter 7. Chapter 7, “straight” bankruptcy, is the fresh start that many consumers need. It is a liquidation, but this does not automatically mean debtors lose everything, or more often than not, anything. Chapter 7 is a great way for consumers to keep their homes, if by discharging all other debts (credit cards, medical bills, loans, certain old taxes, etc.), it would free up enough income for them to make the payments on the house and lift them out of financial hardship again. The key to understanding how a home is treated in Chapter 7 is realizing that it is both a debt and an asset. As a debt, the mortgage is dischargeable. However, the lien of the mortgage company on the property is not. In order to keep their home, clients must deal with the mortgage company.
Traditionally, mortgage lenders required only that borrowers be current on the loan and have insurance, and they will not seek to foreclose even though your client is in bankruptcy. Now, these lenders are even more willing to work with clients in Chapter 7 as long as the borrowers are remotely current and making somewhat timely payments. Lenders do not want these houses back, by and large, and I find they are very willing to talk to Chapter 7 clients about keeping the house.
Through the bankruptcy process, debtors can even avoid certain judgment liens on their property. This alone can be a valid reason to file Chapter 7. It is a somewhat complicated process but not that difficult for bankruptcy attorneys. It is based on the impairment of the debtor’s homestead exemption. If the judgment lien impairs their exemption, then the lien can be avoided. Understanding the homestead exemption is critical to advising clients whether to file Chapter 7 or not. States have varying homestead exemptions. Generally the homestead exemption is used by a debtor as a shield to keep the trustee from selling the house; the trustee has to find a buyer for the amount of the loan, plus the homestead exemption, plus realtors’ fees and costs before a house can be liquidated. But the homestead exemption can be used to your clients’ advantage even if they cannot afford the house. Trustees are under a duty to liquidate assets to pay unsecured creditors but only after they pay out the homestead exemption to your client. If a client is on the eve of foreclosure and has no hope of ever affording the mortgage payment, a Chapter 7 bankruptcy will stop that foreclosure, create a bankruptcy estate, and give the trustee the chance to sell the house. So your clients might well get some of the proceeds of the sale of their house where they would not have realized anything in a foreclosure. The homestead exemption can be waived in full or in part, enabling debtors to cut deals with the trustee so they get something out of their house—and be debt free in the process (not a bad place to be, all things considered).
Chapter 13. Chapter 13 bankruptcy is the one sure way to stop a foreclosure and to keep clients in their house. Sounds foolproof, right? Well, not exactly, but Chapter 13 is always an option. Chapter 13 is a debt-reorganization plan for individuals with a regular source of income. Debtors can take up to five years to repay all or a percentage of their debts. It will stop a foreclosure and allow debtors to remain in their homes.
There is a catch, however, and it is a big one: The debtors cannot modify in any way the terms of the primary mortgage. They can repay all arrearages over the five-year plan, but they must also make the regular mortgage payments along the way. So, obviously, if they were having trouble with the payments before, this is not a permanent solution. It is a better fit for situations such as a job loss or cash-flow interruptions where the debtors have their income restored but may not be able to stop the foreclosures.
Chapter 11. Chapter 11 is commonly thought of as business reorganization (i.e., General Motors), but individuals may file it as well. Chapter 13 has debt limits, and Chapter 7 may not be available for high-income debtors or may be undesirable for debtors with lots of assets. Chapter 11 will also allow individuals to reorganize their debts into a manageable plan. (For more, see the article “Chapter 11 Bankruptcy: A Primer.”)
Chapter 12. Chapter 12 is for family farmers or those individuals whose primary source of income is a family-owned farm. Like the small farmer, Chapter 12s are getting more and more rare. A Chapter 12 functions very much like a Chapter 13 except the debtors make annual or semi-annual payments, not monthly ones.
4. Other Options
Bankruptcy should be a last resort. The damage to your clients’ credit is bad and far reaching in ways they may not expect (insurance renewals, for instance). A person may only seek a Chapter 7 discharge once every eight years, so it is important to keep that possibility open as long as possible. If you find yourself with a client who is not a good candidate for bankruptcy relief, some other options are available.
Short sale. A short sale occurs when the home owner finds a buyer for the house, but the selling price is not sufficient to pay off the loan. If properly convinced, the lender will release the lien on the house anyway and allow the sale to proceed and clear title to be conveyed. The first key, of course, is actually finding the buyer. In this current market, buyers are in short supply. But should one be found, it is often at current market values, and not the inflated amount of the loan (often loaned in the 2000s at 100 percent of value then).
The next trick is convincing the mortgage holder to release the lien. The mortgage holder will likely want a current appraisal (not always cheap) and a financial statement of hardship from your client. I am reluctant to produce the latter—by doing so, you are basically spelling out your client’s assets should the deal go south and you end up in litigation with this very lender trying to collect a deficiency balance from your client.
Thus begins a game of chicken and beat the clock all rolled into one. The lender needs to be convinced that foreclosure (and likely Chapter 7) is the probable alternative and that a short sale is the more desirable outcome. It goes without saying, but a short sale is much more likely to be approved by a local bank than a large mortgage company. Then, of course, you have to deal with the second mortgage if one exists. Secondary lienholders have even more reason to make a deal as a foreclosure will likely leave them out in the cold. Do not underestimate or under-utilize your client’s realtor in this scenario. Let the realtor negotiate with the lender; you can function as the backup to explain the dire financial situation.
But just as important as getting the lender to agree is getting the lender to release your client from the remainder of the debt. Often the lender will not. Most banks that took the federal bailout money are not as willing (or as able, thanks to their Mob-like fed partners and underwriters) to forgive debt. But they will, especially if they are a local bank or credit union. This is where you can earn your fee as attorney by again painting the bleak picture of the consequences should the lender decline.
Two other traps exist. The first is the dreaded 1099. When banks forgive debt, they must issue a 1099 to your client claiming the forgiven debt as income for your client. I am not a tax attorney, but I do know this does not count as income if your client is insolvent; still, you certainly need to prepare for this. Second, do not give the lender the name of your buyer until the lender agrees to the short sale—otherwise, the lender may go ahead and foreclose, and then sell to your buyer anyway. (Yes, I have seen this happen.)
Deed in lieu. Foreclosures are expensive for lenders. Legal fees, advertising fees, realtor fees, all can add up. To short circuit these fees, you can offer the lender the house back free and clear: The client will just sign it right back over to the lender. We assume, at some point, people at lending institutions make decisions like regular business folks.
Lenders in the past have been known even to pay the home owners for signing the house back to them. It has been a while since I have seen this, but it does make sense for them. It will not work, of course, if there is a second or third mortgage. Lenders also need to make sure no judgment liens or materialman liens exist before agreeing, but any good title company can do that. The key, again, is getting the lender to agree to release your client from the remainder of the debt. Offer to pay for the title search as incentive.
Unfortunately, most lenders do not want the houses back at this point. The market is flooded with inventory. This obviously hurts your clients, who are trying to get out from under mortgages they can no longer afford. But it does not mean they do not need competent legal counsel to represent them.