WASHINGTON – Oct. 15, 2008 – Can filing for bankruptcy help homeowners facing foreclosure?
For most people, trying to negotiate changes in their loan with help from a housing counselor or lawyer is a far better option. While bankruptcy judges can reduce or eliminate certain kinds of debt, they aren’t allowed to alter the total amount owed or interest rate of primary mortgages.
Whether to change this law to help with the mortgage crisis promises to be a fierce battle on Capitol Hill next year. Consumer advocates and Democrats – including Sen. Barack Obama, the Democratic presidential nominee – have been pushing for such a change, arguing it would benefit troubled homeowners.
Republicans and the mortgage industry have fought intensely against this idea, saying it would make lenders less willing to lend and thus would push up interest rates. The Mortgage Bankers Association says mortgage rates would go up around 1.5 percentage points if judges had more power, while consumer advocates say there would be little to no impact.
Here are some questions and answers related to bankruptcy and your home.
Q: In what situations is filing for bankruptcy a good idea?
A: Filing for bankruptcy might help if your financial problems stem from a mix of sources, like overwhelming credit card debt, medical bills and skyrocketing mortgage payments. “If reducing or eliminating most of your other debts puts you in a position where you can pay your mortgage, then bankruptcy can be of help,” said Henry Sommer, president of the National Association of Consumer Bankruptcy Attorneys.
It also can help owners of rental properties, as those loans can be modified.
Q: What kind of bankruptcy filings are there?
A: There are two basic options: a Chapter 7 bankruptcy that eliminates debts or a Chapter 13 bankruptcy, which allows an individual to reorganize their finances and pay down their debt over several years.
However, a 2005 change to federal law made it harder to walk away from debt. Those with above-average incomes are barred from declaring Chapter 7 except under special circumstances and must instead file a repayment plan under the more restrictive Chapter 13.
Q: Why can’t a judge alter my mortgage?
A: A 1993 Supreme Court decision bars judges from altering first mortgages on primary homes, though such changes are allowed on loans for vacation homes, motorcycles, boats and other kinds of property. Consumer advocates say this is unfair, while mortgage lenders say it benefits the vast majority of borrowers who don’t fall into bankruptcy.
“It was a protection that was designed to keep mortgage credit for primary residences cheap,” said Francis Creighton, the Mortgage Bankers Association’s chief lobbyist.
Q: If you can’t eliminate a first mortgage in bankruptcy, what about my second mortgage?
A: Bankruptcy judges can take second and third mortgages and reclassify them as “unsecured debt.” If you file for bankruptcy, that takes last priority in terms of what debt gets paid.
Q: Are there any other advantages to filing for bankruptcy if you’re facing foreclosure?
A: It can delay a foreclosure proceeding, allowing you to stay in your home longer. However it might only get you an extra month or two. “Bankruptcy will give you a little breathing space but not much,” said Adam Levitin, a Georgetown University law professor.
Q: Am I less likely to be able to negotiate changes in a problem loan if I file for bankruptcy?
A: Quite possibly. Stephen Elias, a Northern California bankruptcy attorney and author of “The Foreclosure Survival Guide,” says one of his clients recently was denied a loan modification because he was already in bankruptcy court.
In the end, with the federal government trying to get lenders to renegotiate their loans, bankruptcy might not be the best solution.
“It used to be a really good idea,” Elias said. “I’m not so sure anymore.”
Q: Are there other pitfalls of filing for bankruptcy?
A: You could spend years trying to get your credit back in shape because a bankruptcy filing is a serious blemish on your credit record. And that can translate into big problems next time you need to borrow money.