I have read your blog and you are very through so I write you with hopes that you might answer this question for me. I file Chapter 7  in 08, and did not reaffirm my loan. I am still living in the house and did make some payments. However, i have not for the last 8 months. It is my understanding that I must sign a document to reaffirm and that continuing payment in itself is not a reaffirmation…or?  Well it gets a little more complicated.  My house is valued at $410,000 and the bank has offered me a deal that is going to be hard to refuse. They have agreed to let me do a short re-fi in the amount of 180k.  If I agree to that is that in itself a reaffirmation?

Here is my response: in most cases, when you take out a mortgage loan, you are signing two different types of agreements.  The first type is a promissory note whereby you personally agree to make the payments.  The second type of obligation creates a property lien, meaning that you, as the owner of the property, pledges that property as collateral for the loan.

When you file a Chapter 7 and receive your discharge, your personal obligations are extinguished.  However, a Chapter 7 discharge does not eliminate the mortgage company’s lien against your property.  If you “reaffirm” your mortgage, you are actually reaffirming the promissory note and your personal obligations to pay.

For years, many bankruptcy attorneys advised their clients to avoid signing reaffirmation agreements for mortgages, car loans or any other secured debt.  The reasoning – even without a personal “guarantee” lenders are protected by the property lien.  If the lender is willing to accept payments (the so-called “stay and pay” option), the now discharged debtor keeps his property, keeps making payment, but does not have personal liability on the note.

If the debtor misses payments, the lender would still have the right to foreclose or repossess based on the property lien.  The debtor would not have personal liability for any foreclosure or repossession deficiency because his personal liability was extinguished in the bankruptcy.

There is a downside to this “stay and pay” strategy.  First, the debtor does not get any credit report benefit for making payments.  Because the debtor’s personal obligations have been extinguished, the lender no longer reports either a positive or a negative payment history.   A positive payment history from a mortgage company can be a good way to restore credit after bankruptcy, and if you do not reaffirm, you will not get this benefit.

Second, there is the “uncertainty factor” if you do not reaffirm.  Most mortgage or vehicle finance installment notes contain a default provision that includes bankruptcy as a default trigger.  In theory, at least, once your bankruptcy is closed (and the automatic stay of bankruptcy terminated), your lender could declare your loan in default and take action under State law to recover the collateral.  In my experience, lenders would much rather have monthly payments than your collateral but this risk does exist.

Finally, many of my readers have asked me if there is such a thing as “constructive reaffirmation” meaning that by making payments, are you in effect re-obligating yourself?  Are you creating a contractual obligation by your actions?

I think that the answer to this depends on State law but I would suspect that a mortgage or vehicle lender would have a hard time making this argument.  In many States (such as in Georgia) a financial obligation related to real estate must be written and they must have specific terms.  As a matter of general contract law, a contract usually will not be enforceable if its terms are not specified.   I would argue therefore that a debtor’s actions of simply making payments and the lenders actions of accepting such payments should not be enough to create personal liability on the part of the debtor.  I would be interested to know if any of the attorneys who read this blog have a different opinion or if anyone is aware of any case law that says otherwise.

At a minimum, if a lender tries to make the argument that you have somehow re-obligated yourself personally by your act of making payments, I would insist that the lender provide you with case law or other support for its position, and you should consult with a lawyer before agreeing to any payment or taking any action (like signing a new, valid contract) that could create personal liability.

My reader states that his lender has proposed a refinance for $180,000.   He did not say, but I presume that his prior (discharged) mortgage was much higher than this and that his current payments under the “stay and pay” are based on this higher balance.  If he enters into a mortgage contract for $180,000, that contract will function like any other mortgage – and include both personal liability under a promissory note as well as a property lien.   It is not a reaffirmation because the bankruptcy is over – instead, the proposed $180,000 loan deal is equivalent to a new mortgage.  This proposed deal could result in lower payments plus positive credit history, but it will also create personal liability that currently does not exist.  I would certainly advise my reader to discuss his options with an attorney so that he will fully understand the implications of his decision.

These homeowners may have received foreclosure notices that suggest that the mortgage lender intends to negotiate or modify their mortgage.   Georgia law now provides that all foreclosure notices must include a “negotiation provision.”   O.C.G.A. Section 44-14-162.2 provides:

Notice of the initiation of proceedings to exercise a power of sale in a mortgage, security deed, or other lien contract shall be given to the debtor by the secured creditor no later than 30 days before the date of the proposed foreclosure. Such notice shall be in writing, shall include the name, address, and telephone number of the individual or entity who shall have full authority to negotiate, amend, and modify all terms of the mortgage with the debtor, and shall be sent by registered or certified mail or statutory overnight delivery, return receipt requested, to the property address or to such other address as the debtor may designate by written notice to the secured creditor.

However, in real life, very few of these homeowners have had much success in reaching a deal with their lenders.

What about the highly touted HAMP program?   A quick search on the Internet reveals dozens of articles suggesting that, to date, HAMP is not working.

Now comes word that the federal government has modified HAMP to include homeowners in bankruptcy with new guidelines effective on June 1.   Supplemental directive 10-02 specifically addresses the applicability of HAMP to homeowners in bankruptcy.

These directives are intended for mortgage servicers and set out numerous obligations for servicers.   I did find a fairly comprehensive Making Home Affordable FAQ section written for borrowers on the MakingHomeAffordable.gov site.

In reviewing the HAMP materials, it appears to me that the program is designed to direct homeowners to approved HAMP counselors, rather than to have homeowners apply directly.  Further there appear to be regulations that apply to mortgage servicers where they must proactively advise homeowners of possible eligibility.  The on-going issue – the HAMP rules are so complex that most individuals will have no idea about whether they are eligible.   For example, to qualify for a modification, here are the requirements set out in the FAQ:

• Be the owner-occupant of a one- to four-unit home.
• Have an unpaid principal balance that is equal to or less than:
  • 1 Unit: $729,750
  • 2 Units: $934,200
  • 3 Units: $1,129,250
  • 4 Units: $1,403,400
• Have a first lien mortgage that was originated on or before January 1, 2009.
• Have a monthly mortgage payment (including taxes, insurance, and home owners association dues) greater than 31% of your monthly gross (pre-tax) income.
• Have a mortgage payment that is not affordable due to a financial hardship that can be documented.

Would you know what documents to produce, or how to calculate 31% of your monthly gross income?  The government goes on to advise you that “only your servicer will be able to tell you if you qualify.”  In other words, you are expected to turn to the foreclosing lender to help you apply for a program that will stop foreclosure.

Thanks to Las Vegas bankruptcy attorney Randy Creighton for highlighting the June 1, 2010 HAMP changes on his well researched blog post.

The mortgage creditor went first and presented her client’s case:  the debtor had filed a bankruptcy on the morning of July 7, 2009 minutes before the lender sold the debtor’s house on the courthouse steps.  The lender was not aware of the filing and proceeded to foreclose.  When the lender’s attorney returned from the courthouse, he discovered that a bankruptcy had been filed, so he did not record the deed.

Instead, the lender retained bankruptcy counsel who filed a motion have the bankruptcy annulled and the foreclosure validated.   If validated title would pass and the lender would now be the title owner of the property.  In such a situation the debtor’s bankruptcy would offer no protection and the debtor would be subject to eviction.

The mortgage company’s attorney noted that this was the fifth bankruptcy filed by the debtor and his wife, and the third case filed this year to stop a foreclosure.   In none of the cases filed this year did the debtor or his wife make any payments to the trustee or pay anything to the mortgage company.  In none of these cases did the debtor or his wife file any of the required bankruptcy paperwork.

Clearly the debtor and his wife were acting in bad faith, argued the mortgage company’s lawyer, and they should not be allowed to misuse the bankruptcy process.

What would the debtors have to say?  The debtor and his wife appeared pro se (without an attorney).  They told the judge that they filed this bankruptcy to save their home, where they lived with their 4 children, and the wife’s sister and her 3 children.

They further explained that the bankruptcy paperwork they filed was prepared by a “paralegal” from a “foreclosure prevention” company.   The paralegal had instructed them to file the Chapter 13 to stop the foreclosure and to give the company a chance to continue its negotiations with the mortgage lender.  Now, however, the foreclosure prevention company did not seem to be in business anymore – its telephone number was disconnected and its st0refront abandoned.

Now, they just needed some time to obtain representation and to restart negotiations with the lender.   They were victims of a foreclosure rescue scam (the same company that had misled them twice before this year) and now they finally realized that they were on their own.

What would you do in this situation?  What did the judge do?  The answer – see my next post….

I may be on the right track in obtaining more information.  One of my new colleagues at Solo Practice University (where I teach a class about creating a Social Security disability practice) is an attorney in New York who has actually represented clients and has obtained mortgage modifications.  She will be teaching a class about real estate law at SPU and I hope to be able to pick her brain about mortgage modifications.

In the meantime, here is a link to a recent blog post that Stefanie wrote entitled The Top 5 Loan Modification Myths.   I hope that more solid information from legitimate professionals who understand mortgage modification becomes available so I can bring it to you in the pages of this bankruptcy blog.

Let’s start with some of the financial institutions that invested so heavily in those profitable subprime mortgages and securities that were created to allow investors to sell and resell parts of these mortgages.  When you hear the term “securitization” it means that an investment banker has created a security (think share of stock) from a package of loans.   Lenders and investment bankers got fat and greedy.

Remember the old line, solid mortgage lenders like Countrywide, Chase and Bank of America?  Remember the investment banking giants like Merrill Lynch and Lehman Brothers.  These institutions had made so much money lending, servicing and selling subprime loans and securities derived from those loans that they took outrageous risks. They borrowed billions of dollars to expand their subprime business.  When the subprime market collapsed, these institutions lost their cash flow and their credit ratings.  Lehman Brothers went out of business.  Merrill Lynch, formerly the most prestigious of all brokerage houses, had to sell itself to Bank of America at a fraction of its former value.

What does all this mean to you?   Many national, regional and local banks invested heavily in profitable mortgage backed securities.  Others made risky real estate loans, expecting to quickly sell these loans to investment bankers.  Now banks have to eat investment losses.  Real estate loans that were “performing” are not “non-performing.”  Banks do not want to loan money to anyone but borrowers with perfect credit.  The market for loan backed securities is much smaller.  When credit tightens, businesses cannot get loans to expand because banks see these loans as speculative.  Homeowners with less than perfect credit cannot refinance.

This contraction in credit has had other effects.  Housing prices have collapsed in many markets because the market perceives that prior valuations were artificially inflated.  Easy money meant that less qualified buyers could afford bigger and more expensive houses.  Now there are fewer qualified buyers and the market is correcting its prior overvaluation.

Homeowners, especially those with adjustable rate mortgages, are facing increasing mortgage costs, while their home values have gone down and the likelihood of unemployment has increased.  Refinancing is more difficult because real estate may be worth less on the open market than current debt.   More and more homeowners have turned to bankruptcy in an effort to save their homes.  Many others have decided to just walk away from homes worth tens of thousands less than what is owed.  Abandoned homes in a neighborhood then drive values down further.

Why is the housing market in the United State in trouble?   A big part of the problem arises from a collapse of  the so-called “subprime” mortgage market.  Until just a few months ago, subprime lending – or lending to credit challenged borrowers was a big profit center for many banks and mortgage lenders.   Subprime lending was so profitable that many lenders changed their business models to accommodate the demand for subprime credit.  Subprime loans, or more accurately, pieces of subprime loans, were sold off by loan originators as securities in the stock market.

For many years, everyone involved in the subprime market was making money – mortgage brokers got paid for selling the loans, originators earned fees, underwriters got paid for “securitizing” the loans into investment vehicles, brokers got paid for selling the securities and middlemen of many stripes got paid for handling the loans or mortgage backed securities.

In my Atlanta area bankruptcy practice, I saw many indications of fundamental problems in the housing market.  I can recall many discussions with clients who had incurred hundreds of thousands of dollars of debts despite modest incomes and average to below average credit.   It was not uncommon for me to see a two income family earning $60,00o to $80,000 per year, servicing $50,000 in credit card debt and a $300,000 mortgage.   Often the mortgages were adjustable rate loans with teaser rates or, worse, interest only loans.  Often the homeowner could survive as long as there was no interruption in income or other hiccups.  All it took was a missed credit card payment or short term layoff and the dominoes began to fall.  The folks I was seeing often were families that had been hanging on, but who no longer had cash flow to keep everything afloat.

Unfortunately, all of the players in the subprime game failed to recognize that more and more subprime borrowers were people like my clients – honest and hardworking families who had succomed to the lure of easy credit and who who did not have enough cash flow to pay everything back.  Homeowners looking for solutions to mortgage problems had few places to turn.

Many of these borrowers were poor credit risks because they did not have enough income to weather even minor changes in their budgets – a car wreck that caused insurance premiums to go up, a death in the family that required a $700 plan flight, a difficult pregnancy, an unexpected job layoff.

Despite what really were the best efforts of the borrower, and after all the slicing and dicing of the loans, the underlying loans frequently ended up in default.  Some went into default quickly and some went into default after a few years, but a large enough percentage of these subprime loans went into default to convince investors, investment advisors and regulators that the values assigned to the securities derived from subprime loans was artificially high.  Almost overnight, the subprime mortgage market collapsed.

Next – what was the effect of the subprime crash and what can be done to “fix” the problem.

Several of my colleagues in the Bankruptcy Law Network have argued that adding this power to the authority of bankruptcy judges will help stem the foreclosure crisis we are seeing in many cities and towns and that so called “voluntary” mortgage modification programs created by mortgage lenders has not and will not work.

Bankruptcy Law Network founding member Cathy Moran, who I respect greatly, has created a special advocacy page on her website that you can use to encourage your elected representatives to support mortgage modification in bankruptcy.  At  the same time Cathy notes that the judicial mortgage modification legislation now circulating in Congress leaves many unanswered questions.

North Carolina bankruptcy attorney Adrian Lapas, writing on the Bankruptcy Law Network blog, makes a compelling case in favor of judicial mortgage modification – click on the link to read Adrian’s post.

What, then, are the arguments against judicial mortgage modification.   A thoughtful and well reasoned argument against modification comes from Andrew Grossman of the Heritage Foundation.   Mr. Grossman argues that judicial mortgage modification will impose uncertainty and financial loss on mortgage lenders, thereby increasing the cost of mortgage loans in the open market.   Credit, therefore, would further tighten, causing additional limits on mortgage availability.

My personal political leanings tend to favor the libertarian ideal of less regulated markets and fewer limitations on the “invisible hand” of free market capitalism.   However, as a longtime bankruptcy practitioner, I have seen firsthand some of the abuses and outright greed of mortgage lenders and other creditors who use their position of strength and leverage to the disadvantage of sometimes innocent homeowners and consumers.

Ultimately, however, I think that the consumer wields the ultimate power.  In my experience many, but not all, of the folks who end up filing bankruptcy do so because of poor financial decisions and unwise use of credit.   Consumers who end up on the wrong end of unfavorable contracts are often poor credit risks – because of bad decisions made in previous months and years.   Home ownership does not make sense for everyone and if the only way a consumer can get into a house is though an unfavorable mortgage deal, then that consumer should delay the gratification of home ownership.

If there is a silver lining in the current financial mess we find ourselves in, I hope it will be to re-establish responsible lending behavior – both as to lenders and as to borrowers.   It is true that lenders were reckless when doling out money, but borrowers were all too willing to take on financial obligations that they could not afford.

Perhaps the appropriate answer to the judicial modification question would be to so empower bankruptcy judges for a limited period of time in limited mortgage circumstances.   Such a solution might help “rebalance” loan to value relationships but not create yet another government impediment to the free market.

What do you think?

When I first started practicing bankruptcy law some 20 years ago, I was introduced to the term “cram down” which is a kind of bankruptcy lawyer slang for the process of forcibly changing the terms of a contract against a creditor’s interests.  In a typical car loan cram down, you might enter into bankruptcy with four years remaining on a five year note, a monthly payment of $530 per month, an interest rate of 12% and a total outstanding balance of $28,000.   After cram down the interest rate might be 6% and the outstanding balance may be $18,000 (which represents that approximate value of the vehicle) and the monthly payment to the creditor within a Chapter 13 plan might be $250 per month.

As you can see from this example, the purpose of a cram down is to bring a debtor’s obligation more in line with the value of the collateral and prevailing interest rates.  I suspect that Congress allowed cram downs on car loans because it saw a problem in the market place whereby consumers with poor credit were ending up with unreliable used cars at unreasonable terms in the secondary market.

Debtor’s attorneys also included cram down provisions in Chapter 13 plans to modify the terms of other secured loans, such as furniture and jewelry.  However, home loans were specifically excluded from cram down.

In 2005, with the enactment of the BAPCPA changes to the bankruptcy laws, Congress added restrictions to the power of judges to cram down vehicle purchase loans.   In other words the era of freewheeling bankruptcy cram downs was over.   Under the amended law, vehicles purchased less than 910 days prior to the filing of a bankruptcy case were not subject to cram downs.

These new restrictions on the authority of a judge to forcibly modify the contractual terms between a debtor and his car finance company were the result of extensive lobbying on the part of the automobile industry who argued that market forces, not bankruptcy judges ought to set the terms of vehicle purchase financing.

There has been no organized effort to change the rules regarding vehicle cram downs.   Instead, Congress has turned its attention to mortgage loans.   Perhaps this is not surprising since the federal government, through its mortgage guarantees, now owns or controls a fairly significant chunk of mortgages owed by Americans.

Legislation is now circulating in Congress that would allow a bankruptcy judge to change the terms of a mortgage, which would involve such things as:

• reducing the outstanding balance to line up with the current market value
• modify the terms (monthly payments)
• change the interest rates

The sense among bankruptcy lawyers is that if this legislation makes it into law, Chapter 13 bankruptcy will become a viable and attractive option to middle class families who might never have considered bankruptcy relief.   Mortgage debt is often a family’s largest obligation and an opportunity to “re-write” one’s mortgage at more favorable terms while at the same time reducing credit card debt and canceling unfavorable leases and service contracts may very will put the bankruptcy option on the table.

Is it a good idea to enable mortgage loan cram downs?   If you have a mortgage and have been contemplating bankruptcy should you wait?  We’ll explore those questions next….