This document provides an overview of bankruptcy and mortgage deficiency basics, including Chapter 7 and Chapter 13 bankruptcy. It discusses what bankruptcy is, reasons for and against filing, eligibility requirements, exemptions, keeping property, costs, strategic defaults, and dealing with mortgage deficiencies. The key points are that bankruptcy provides a financial "fresh start" but can negatively impact credit, and strategic default may be an option to avoid deficiency if the home is underwater.
2. What is bankruptcy? Federal court process by which a debtor can discharge or reorganize their debts. Intended to provide the honest but unfortunate debtor with a “fresh start.”
3. Why file bankruptcy?(Or, what are the upsides?) Automatic stay of all debt collection action. (Including lawsuits, foreclosures, collection calls, etc.) Financial “reboot” Discharge all dischargeable debts Eliminate risk of deficiency (where it exists) Eliminate some tax debts Eliminate credit card debt Get a “fresh start” Look better to lenders (yes, it’s true!)
4. Why not file bankruptcy?(Or, what are the downsides?) FICO hit (immediate but recoverable). Stays on credit for 10 years. Some debts can't be discharged (student loans especially). May have to part with some property (rare, but it happens). Financial affairs will be scrutinized to some degree. Expense and time.
5. Chapter 7 “Straight” bankruptcy. “Liquidation” of non-exempt assets, sale and distribution to unsecured creditors. About 3 months (in most circumstances) Rarely loss of property. Keep home if loans stay current. Yes you CAN discharge some taxes. (“Old and moldy” rule)
6. Chapter 7 Eligibility Must “pass” means test. Adjusted income after below median for state. Must take “credit counseling” class. (Sort of like traffic school for bankruptcy only much shorter.)
7. Chapter 13 3 to 5 year process in which “some” debts are repaid with “disposable income.” Disposable income is calculated by a strict formula. Good: “Super discharge” Can provide discharges of some debts that a Chapter 7 may not. Good: May allow homeowner in default to keep their home. Good: May allow a homeowner to “lien strip” junior deeds of trust that are “wholly unsecured.” Bad: Keeps the debtor in the bankruptcy system for the whole time.
8. Chapter 13 Eligibility No more than $360,475 in unsecured debt, and $1,081,400 in secured debt. Must have “regular source of income.”
9. Keeping your property in bankruptcy It’s simple: Stay current on the payments!!!! Houses and cars treated similarly with minor differences in “reaffirmation” requirements. As a practical matter, statutory exemptions protect most property. Redemption of property back from trustee. Chapter 13 keeps everything unless Ch 13 plan doesn’t pay out as much as a liquidation.
10. Exemptions (“Home Owner”) Depends on your situation: If you have equity in your home above the value of all combined loans: $75k if single $100k if “head of household $175k IF >65 years old Mentally or physically disabled, or >55 years with household income <$15k
11. Exemptions (“Non-Home Owner”) $24,250 “wild card” Can be used for anything: cash, securities, property, art. Usually covers most personal property Timing of filing can be managed to protect certain items All “post petition” wages and income
12. Other Exemptions and Concepts All “post petition” wages and income All IRA,s 401k’s, 529’s (some limits may apply) Most cars, jewelry, art, clothing, furniture, etc.
13. Can I “keep” anything out of bankruptcy? No!!!! All financial affairs (assets, debts, etc.) must be fully disclosed. Intentional omissions or misrepresentations in Bankruptcy is a federal crime. But it’s a disclosure issue: You can pay anyone you want. If you want to lose a piece of property, the easiest way to do that is to fail to disclose in in your schedules. Recent client who “assumed” that taxes had nothing to do with bankruptcy. Another client who “forgot” she owned a house that she’d recently sold. Indicted.
14. Consequences of bankruptcy non-disclosures? Possible loss of discharge May be charged with a crime. Just don’t do it. A good bankruptcy lawyer can fix ANYTHING but a lie.
15. Bankruptcy Process and Procedures Starts with filing a “Petition and Schedules” with the Bankruptcy Court. Which Court depends on your residence. All filings online through CM/ECF system. Usually only one appearance at “meeting of creditors.” Chapter 7: Usually done three months from filing unless there is property to be administered by the trustee. Chapter 13: Can take up to 5 years to payoff the plan and get the discharge.
16. Cost and Attorneys fees(Unfortunately, it ain't free to go broke.) Fees are highly variable, depending on location, attorney’s experience, attorney’s other business. You WILL get what you pay for. (At least on the low end. Few things more dangerous than an underemployed attorney.) Do your best to get an “all in” arrangement. Under most circumstances Chapter 7 MUST be paid pre-filing. (Your attorney can't be a “creditor”). Chapter 7: “Simple” cases, anywhere from $1,700 to $3,500 depending on complexity of assets and debts. Chapter 13: $3,500 to $7,000, again, depending on complexity of assets and debts. Chapter 11? $20,000 to….
17. Can I represent myself? Sure. You can also do your own knee surgery. Generally not a good ideabecause the requirements are highly technical and the penalties for error can be very costly. Lots of calls from people who have spent 6 to 12 months screwing up their own bankruptcy. Costs way more in the long run. Do it right. Do it once.
18. What about “bankruptcy petition preparers?” Another bad idea They’re not lawyers. They’re form fillers. They can’t give legal advice.
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20. Who’s doing it? Mortgage Bankers Association of America walked away from a $79 million obligation in 2010. Studies show that: 20% of homeowners will walk away when the loan-to-value ratio drops below 75%. 63% of people will walk away when deficiency hits $300k. Estimates are that 15% of all foreclosures are “strategic.”
21. Why? “Clean break” from the bank and avoids the months and months of uncertainty and negotiation with a large lending institution that probably doesn’t really want to modify the loan anyhow. If there is any risk of a deficiency, the foreclosure will in all likelihood nuke that lien, and a bankruptcy will discharge the underlying obligation. Starts financial rehab faster. May have better tax implications than a short sale or deed in lieu. Loan mod can make the homeowner stuck in a house that may never recover its value. See 60 Minutes piece by Morley Safer on May 9, 2010.
22. Mortgage Deficiencies What is it? The amount of the unpaid mortgage debt that remains after foreclosure, short sale, trustee’s sale or deed in lieu. Example: House worth $400k. Mortgage of $475k. If bank takes property valued at $400k back, deficiency will be $75k.
23. Can the bank get a deficiency from me? Under some circumstances. Is a question of state law, even in a federal bankruptcy. California law only: Not allowed for “Purchase Money Mortgages.” Literally the mortgage (or HELOC) that was obtained for the purpose of, and actually used for, the purchase of the property. Not allowed for loans in which the bank actually takes the property back by non-judicial foreclosure. Not allowed on first mortgages in which the lender has agreed to a short sale.
24. Most likely deficiency problems Investment property second deed of trusts (“DOT”). Personal residence HELOCs, (seconds or thirds) obtained AFTER purchase of property. E.g. Home improvement loans, home equity loans taken out to pull some cash out of the property. May present tax problems in the form of “cancellation of debt” (“COD”) income. Cancellation of a debt is taxable as ordinary income unless Debt is cancelled in bankruptcy. Property is primary residence. (At least until 2013) Debtor is balance sheet “insolvent” when debt is canceled.
25. How to deal with deficiencies Pay it. Discharge it in bankruptcy Negotiate a discount. Banks typically sell this debt “by the pound.” Meaning that they aggregate large portfolios and sell the lot to bottom feeders and collection agencies. Usually for 3 to 5 cents on the dollar. Anything over that is gravy. Success with this will depend on how likely the owner of the debt thinks they will be able to get more. High income or significant wealth? You’ll pay more.
26. Conclusions Don’t do your own knee surgery. These issues are not easy to sort out. Talk to a lawyer (and a tax accountant). Even so, in the hands of a qualified and experienced attorney, mostof these problems have relatively simple legal and financial solutions. Simple doesn't mean easy: Can be very stressful, and can make you feel like you’re quite alone. Only regret any client has ever expressed is that it took them so long to take the plunge.
27. Bankruptcy and Deficiency Basics Chapter 7 and Chapter 13 David C. Winton, Esq. 2 Ranch Drive, Suite 8 Novato, CA 94945 Tel: 415.421.5800 www.dcwintonlaw.com Email: david@dcwintonlaw.com Thank you.
