The Truth About Bankruptcy

FIVE IMPORTANT FACTS EVERY HOMEOWNER SHOULD KNOW ABOUT BANKRUPTCY
©2005, Sergio Cabanas, Attorney at Law
THE TRUTH ABOUT BANKRUPTCY:

Five Important Facts Every Homeowner Should Know About Bankruptcy

By: Sergio Cabanas, Attorney At Law

FACT    #1
HOMEOWNERS MUST QUALIFY FOR CHAPTER 13

If a homeowner chooses to file bankruptcy when in foreclosure, the term “Automatic Stay” goes into effect.  This means the foreclosure is stopped immediately and the homeowner has fifteen days to fill out all the paperwork of all the creditors to whom he owes money, and also they must list their current financial situation.  Then within twenty to forty days, there will be a meeting of the creditors to try to set up a payment plan.

The bankruptcy rules to “qualify” for Chapter 13 are as follows:

• Debtor is an individual, or individual and spouse who reside(s) in the United States.

• Debtor, or at least one spouse, must have “regular” income from wages, salary, regularly paid commissions, a sole proprietorship business operated by the debtor, investment income, social security benefits, disability benefits, a private pension, or some other regularly paid income source, or some combination of these.

• Debtor’s (or debtor’s and spouse’s) secured debts do not exceed $750,000 and unsecured debts do not exceed $250,000.  These amounts may not be stacked (i.e., doubled) when a married couple files a joint case.
 

If the homeowner does not meet the eligibility requirements for Chapter 13, he will have to convert to Chapter 7, which means he would have to liquidate and lose his home anyway, or they could withdraw or dismiss the bankruptcy case -- and the foreclosure sale will take place on auction day!

In addition, the debtor is not eligible for Chapter 13 if he is a stockbroker or commodity broker, or if he was a debtor in a prior bankruptcy case that was dismissed within the last 180 days, if the case was dismissed by the debtor after the automatic stay had been lifted.

FACT    #2
HOMEOWNERS WAGES CAN/WILL BE GARNISHED

If the homeowner has a job, his employer can/will be contacted about the bankruptcy to possibly garnish the wages of the homeowner for the Chapter 13 plan.  This is a negative action that may hinder a homeowner’s decision about filing.  The Bankruptcy Code states, “When computing the amount withheld for wage garnishment, all compensation, including overtime pay, payments for unused vacation or sick pay, bonuses, and commission pay is subject to garnishment.”  A Chapter 13 plan is a minimum of three years and can be as high as five years.  Not many people would like their wages garnished for that long.

If the homeowner is self-employed, then they must personally pay the plan payment to the Court.  If they do not make the payments on time, the plan could be dismissed and their home could be foreclosed on.

FACT    #3
HOMEOWNERS MUST STILL PAY BACK-PAYMENTS EARLY IN THE PLAN

The homeowner is in foreclosure because he is several months behind on his payments.  If he files bankruptcy (Chapter 13), the Code states that the back payments must be made up early in the plan.  The homeowner must also make his regular house payment on time.  This means the homeowner’s monthly house payment will be higher once the Petition for Chapter 13 is filed.  The homeowner will also have to pay all of his other creditors on the payment plan.  In this case, the bankruptcy may actually create more problems than it solves.

There are 5 classes of creditors that are paid through the Chapter 13 plan.  They are as follows:

1. Administrative Claims – must be paid in full.

• Includes Chapter 13 Trustee’s fee of 10% of the amounts paid through the monthly plan payments, and may include attorney’s fees of debtor’s attorney.

• Trustee’s fee and debtor’s attorney’s fees must be paid through the plan.

2. Priority Claims – must be paid in full.

• Same debts that receive priority in a Chapter 7 distribution, including taxes, certain wages owed to employees, and so on.

• These claims must be paid through the plan.

3. Defaults on home loans – must be “cured” if the home loan is being reaffirmed.

• Past due payments on the home mortgage loan(s) must be made early in the plan payments if the debtor intends to reaffirm on the home mortgage(s).

• If reaffirming on the home loan, the debtor must also make current mortgage payments as they come due.

• Home mortgage defaults may be paid through the plan.

4. Defaults on car loans – must be “cured” if the car loan debt is being reaffirmed.

• Just like the home mortgage, car payments must be made as they come due.

• Past due payment must be pro-rated in addition to the current car payment.

5. Unsecured Creditors – must receive a dividend.

• Unsecured creditors must receive some money in the plan as per the minimum three year plan.

Secured creditors whose only collateral is an interest in the debtor’s real estate used as a residence (first or second mortgages) may not have their rights modified by a Chapter 13 plan (reducing monthly payments or extending loan repayment period, changing interest rates, etc.) without secured creditor’s consent.  This means that a Chapter 13 debtor may not redeem his interest in an under-secured first or second mortgage by paying the equity value of the home.  If a debtor wants to keep his house, he must reaffirm all mortgage debts against the house.

The goal in a typical Chapter 13 plan is to cure defaults on home and car loans and to cure their defaults within a reasonable amount of time (two to three months) through the plan, while the debtor continues to make current payments on these debts.  Current payments on the home and car are usually the two biggest items paid by most debtors, and paying these outside the Chapter 13 plan saves the debtor money, since the trustee takes 10% of all amounts paid through the plan.  The trustee may allow them to pay these outside the plan if they have a good payment history, but if they don’t, the trustee may insist that these payments be made through the plan.

FACT #4

BANKRUPTCY WILL AFFECT HOMEOWNER’S CREDIT FOR TEN YEARS OR MORE

Most people know a bankruptcy affects your credit rating.  But let’s dig a little deeper.  A lot of people seem to think it’s no big deal to file bankruptcy.  Some attorneys that try to convince people in foreclosure to file bankruptcy by telling them they will still be able to get loans in the future for cars or other homes, etc.  This is true to a certain extent, but the reality of it is that it does affect your future in a negative way.

With bankruptcy on your credit record, you can still get future loans, but you will pay higher interest rates and down payments.  The interest rate on a car or home can be so high that the payments are outrageous.  That’s why they are willing to give you a loan.  A bankruptcy can stay on your record for up to ten years.  A Chapter 13 bankruptcy stays on your record while the three to five year payment plan is in effect and could stay on up to ten years beyond that. 

There are cases where an individual with a high income and gets married, but that person’s old bankruptcy prevents that person and the new spouse from getting a house loan.  Even after the ten-year period is over, they may be required to put up a twenty percent down payment in order to get a loan.  If they try to buy a car, they must not only be required to make a large down payment, but they may also be required to pay by the week.  If they miss the weekly payment, the car could be repossessed.

What if their circumstances change and they cannot meet the requirements of the Chapter 13 plan?  They could end up in foreclosure and have a foreclosure AND a bankruptcy on their credit rating, thus making it hard to rent a place to live.  Homeowners must understand the long-term effects of their decision to file bankruptcy.

FACT    #5
HOMEOWNERS MAY STILL LOSE HOME TO FORECLOSURE ANYWAY

We have seen cases over the years where we’ve offered alternative solutions to people in foreclosure who nevertheless choose to file Chapter 13 in the effort to keep their home. A few months later we see their home in the legal notices and then see their house being auctioned off at the courthouse steps. 

This is a sad situation for the homeowners because they thought they could keep their home by filing bankruptcy.  However, not only do they have a foreclosure on their credit record, but also a bankruptcy too – in addition to losing their home!  Where will they live now?

We started to see this situation so often that we wanted to find out why.  This is when we realized that these homeowners decided to file bankruptcy as a solution to their foreclosure problems, but only end up making it worse!  So if we could find out why a home still goes to foreclosure even after filing bankruptcy, we could inform homeowners about why bankruptcy may not always solve their problem, before they file for bankruptcy, destroy their credit, and lose their home.

The main reason many people still lose their home after filing for bankruptcy is as follows:

When a homeowner in foreclosure files bankruptcy, the foreclosure auction is stopped immediately because of the “automatic stay”.  This stops all creditors from collection of debts, at least temporarily.  The duration of the automatic stay is from the time the case is filed until the case is dismissed, or a discharge is granted, or a particular creditor is successful in having the stay lifted.  In Chapter 13 cases, the automatic stay is in effect during the entire time the debtor is performing his plan.  Individual creditors may file a motion to have the automatic stay lifted in order to allow a particular collection activity by that creditor.  The collection activity must be consistent with the relief to which that creditor is entitled under bankruptcy law.

This “automatic stay” seems attractive to anxious homeowners who are facing the possibility of losing their home in foreclosure. However, this “stay” can be removed or “lifted” by a creditor under certain circumstances.

Lifting the Automatic Stay

There is no general “lifting” of the automatic stay while a bankruptcy case is pending.  Rather, a particular creditor may petition the Court to lift the automatic stay in order to engage in a particular collection activity, usually involving property that is subject to a security interest (mortgage).

In filing a Motion to Lift the Automatic Stay, the creditor must assert one of the bases for lifting the stay, namely:

• Lack of adequate protection; or
• Lack of equity.

Lack of adequate protection means the value of the secured creditor’s collateral (home) is likely to decline while the bankruptcy case is pending, unless the stay is lifted.  The secured creditor is trying to protect the value of his collateral.  The most common form of adequate protection is for the debtor to make periodic payments on the home so as to minimize the erosion of the home’s value to the creditor.

“Lack of equity” refers to the debtor having no measurable interest in the property.  This is why most homes go to auction.  Lack of equity in secured property is the most common method used by creditors to lift the automatic stay in consumer bankruptcy cases.  In determining if the debtor has any equity in the property, add to the balance all of the late payment penalties, commissions, and closing costs of selling the property (approximately 10% of the sales price of residential real estate) to what the debtor owes on the debt.  If the total of these figures equals or exceeds the likely price of the property in a foreclosure sale (at the courthouse steps) then the debtor has no equity in the property.

Real estate sold at a foreclosure sale generally sells for no more than 80% of the fair market value.

This means that the home could be released to go to auction unless there is more than 30% equity.  (Otherwise it is no benefit to the bankruptcy case.)

In summary, the Code gives us three reasons to explain to the homeowner that there is a possibility the home could be released from the bankruptcy:

1. Debtor can’t/won’t perform the plan.
2. Lack of adequate protection.
3. Lack of equity.

CONCLUSION:

Whether to file bankruptcy is an important decision. At first, it may seem like an attractive alternative to homeowners that are faced with the threat of foreclosure. However, it may not be suitable in your particular situation.

Of course, a major disadvantage in filing bankruptcy includes paying all of the expensive attorney’s fees and court costs. As mentioned above, some of the other disadvantages of bankruptcy include the following:

(1) It is very difficult to be eligible for special debt relief that the homeowner may be trying to get through Chapter 13.

(2) Even if a homeowner qualifies for special bankruptcy protection, the homeowner’s income can still be garnished for 3 to 5 years.

(3) The homeowner may still have to make up for back payments in addition to keeping up with current mortgage payments, which means that the total monthly house payment could be higher!

(4) Bankruptcy will have a negative impact on the homeowner’s credit for 10 years or more, often requiring the homeowner to make higher down payments and/or pay higher interest rates in order to qualify for future loans.

(5) Even if the homeowner manages to qualify for bankruptcy, the lender can still be able to remove bankruptcy’s protection and foreclose on the house!

The purpose of this summary is to help you, as a homeowner, by providing you with important facts you need to know as a homeowner to make an intelligent, informed decision. We encourage you to consult with an attorney of your choice, and ask him or her about the possible disadvantages of bankruptcy listed in this summary so you can better decide if bankruptcy will help you in your situation – or actually hurt you!

Of course, we are also available to meet with you to provide a free, caring, and confidential consultation where we can provide you with alternatives to bankruptcy that may work better for you and your family.

Call us today -- and let our family help your family!