Tag Archives: Chapter 13

Supporting The Consumer Bankruptcy Reform Act

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Petar Milošević

I, along with 73 other law profs, signed a letter of support drafted by Professor Pamela Foohey (Indiana). It reads in part,

Congress enacted our current Bankruptcy Code in 1978. Much has changed since then. Even after adjusting for population growth and inflation, Federal Reserve data show that credit card debt has tripled. In 1978, student-loan debt was such a small part of household finances that the Federal Reserve did not even separately track it. Today, student-loan debt is the largest component of household debt except for home mortgages. In 1978, asset securitization was in its infancy. Mortgages and auto loans are now routinely bundled and sold to investors, separating the servicing of the loan from the financial institutions that own the loan. Advances in technology have made it easier for debt collectors to hound consumers even for debts that are decades old. In 1978, what we now think of as the Internet was a little-known research tool for academics instead of a global information revolution that has affected how Americans interact, including with consumer lenders, attorneys, and the court system. Given all these changes, it is little surprise that a forty-year-old bankruptcy law no longer serves our needs today.

The central piece of the Consumer Bankruptcy Reform Act is to create a new chapter 10 for individual bankruptcy filers. The Act also eliminates chapter 7 as an option for individual filers and repeals chapter 13. Individuals will remain able to file under chapter 11 (those with debts over $7.5 million will be required to use that chapter), but for most people, the new chapter 10 will be a single point of entry into the bankruptcy system.

The single point will substantially improve the consumer bankruptcy system by replacing the current structure where consumer debtors must choose between a chapter 7 liquidation bankruptcy or a chapter 13 repayment plan bankruptcy. There are substantial differences around the country in the rates at which people use chapter 7 and chapter 13. In 2019, only 9.6% of the bankruptcy cases in the District of Idaho were chapter 13 cases as compared to 81.0% of the cases in the Southern District of Georgia. The gaping disparity itself is an indictment of a federal system that the Constitution directs to be “uniform.”

Buying after Bankruptcy

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Realtor.com quoted me in Buying a House After Bankruptcy? How Long to Wait and What to Do. It opens,

Buying a house after bankruptcy may sound like an impossible feat. Blame it on all those Monopoly games, but bankruptcy has a very bad rap, painting the filer as someone who should never be loaned money. The reality is that of the 800,000 Americans who file for bankruptcy every year, most are well-intentioned, responsible people to whom life threw a curveball that made them struggle to pay off past debts.

Sometimes filing for bankruptcy is the only way out of a crushing financial situation, and taking this step can really help these cash-strapped individuals get back on their feet. And yes, many go on to eventually buy a home. Only how?

Being aware of what a lender expects post-bankruptcy will help you navigate the mortgage application process efficiently and effectively. Here are the steps on buying a house after bankruptcy, and the top things you need to know.

Types of bankruptcy: The best and the worst

There are two ways to file for bankruptcy: Chapter 7 and Chapter 13. With Chapter 7, filers are typically released from their obligation to pay back unsecured debt—think credit cards, medical bills, or loans extended without collateral. Chapter 13 filers have to pay back their debt, only it’s reorganized to come up with a new repayment schedule that makes monthly payments more affordable.

Since Chapter 13 filers are still paying back their debts, mortgage lenders generally look more favorably on these consumers than those who file for Chapter 7, says David Carey, vice president and residential lending manager at New York’s Tompkins Mahopac Bank.

How long after bankruptcy should you wait before buying a house?

Most people applying for a loan will need to wait two years after bankruptcy before lenders will consider their application. That said, it could be up to a four-year ban, depending on the individual and type of loan. This is because lenders have different “seasoning” requirements, which is a specified amount of time that needs to pass.

Fannie Mae, for example, has a minimum two-year ban on borrowers who have filed for bankruptcy, says David Reiss, professor of law and academic programs director at the Center for Urban Business Entrepreneurship at Brooklyn Law School. The FHA, on the other hand, has a minimum one-year ban in place after a bankruptcy. The time is measured starting from the date of discharge or dismissal of the bankruptcy action. Generally the more time that passes, the less risky a once-bankrupt borrower looks in the eyes of a lender.

Reiss on SCOTUS Junior Lien Decision

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Bloomberg BNA quoted me in Nagging Economic and Credit Questions Dampen Bankruptcy Victory for Bankers (behind paywall). It reads, in part:

The U.S. Supreme Court delivered an important bankruptcy ruling for bankers that doesn’t, however, do anything about still-struggling homeowners (Bank of Am. N.A. v. Caulkett, 2015 BL 171240, U.S., No. 13-cv-01421, 6/1/15); (Bank of Am. N.A. v. Toledo-Cardona, 2015 BL 171240, U.S., No. 14-cv-00163, 6/1/15).

In a June 1 decision, the court said Chapter 7 debtors cannot void junior liens on their homes when first-lien debt exceeds the value of the property, as long as the senior debt is secured and allowed under the Bankruptcy Code.

The decision is a victory for Bank of America, which held both junior liens in the two related cases, and for banking groups that said a different result could have destabilized more than $40 billion in commercial loans secured by similar liens.

But Brooklyn Law School Professor David Reiss June 2 said the case highlights the need for a broad remedy for homeowners who have continued to struggle to make payments since the financial crisis.

“The bank’s position as a legal matter is a very reasonable one, but from a policy perspective we needed and still need a bigger and more systemic solution to the problems that households face,” Reiss told Bloomberg BNA.

*     *     *

[S]ome said the ruling highlights economic questions on several levels.

Reiss, who coedits a financial blog, June 2 said the case shows the federal government’s inability to deal head-on with the impact of financial turmoil in 2008 and 2009.

“Not enough is being done to move households beyond the crisis, and it’s bad for households and it’s bad for the financial sector,” Reiss said. “Here we are seven or eight years later and we’re sitting here with these valueless second mortgages. We’re just slogging through the muck and we’re not coming up with any good solutions to get past it.”

Strip-Downs Are Good

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The Philadelphia Fed has posted a Working Paper, Using Bankruptcy to Reduce Foreclosures: Does Strip-Down Of Mortgages Affect The Supply of Mortgage Credit? The paper’s abstract reads,

We assess the credit market impact of mortgage “strip-down” — reducing the principal of underwater residential mortgages to the current market value of the property for homeowners in Chapter 7 or Chapter 13 bankruptcy. Strip-down of mortgages in bankruptcy was proposed as a means of reducing foreclosures during the recent mortgage crisis but was blocked by lenders. Our goal is to determine whether allowing bankruptcy judges to modify mortgages would have a large adverse impact on new mortgage applicants. Our identification is provided by a series of U.S. Court of Appeals decisions during the late 1980s and early 1990s that introduced mortgage strip-down under both bankruptcy chapters in parts of the U.S., followed by two Supreme Court rulings that abolished it throughout the U.S. We find that the Supreme Court decision to abolish mortgage strip-down under Chapter 13 led to a reduction of 3% in mortgage interest rates and an increase of 1% in mortgage approval rates, while the Supreme Court decision to abolish strip-down under Chapter 7 led to a reduction of 2% in approval rates and no change in interest rates. We also find that markets react less to circuit court decisions than to Supreme Court decisions. Overall, our results suggest that lenders respond to forced renegotiation of contracts in bankruptcy, but their responses are small and not always in the predicted direction. The lack of systematic patterns evident in our results suggests that introducing mortgage strip-down under either bankruptcy chapter would not have strong adverse effects on mortgage loan terms and could be a useful new policy tool to reduce foreclosures when future housing bubbles burst.
This paper seems to cut through some of the hyperbole that surrounds this topic. Its concluding paragraphs indicate how a modest introduction of strip-downs would have only a modest impact on the availability of mortgage credit. It contrasts such a modest step with more far-reaching proposals, such as using eminent domain to take underwater mortgages throughout an entire jurisdiction. The paper seems to argue that the more modest proposal could be acceptable to the lending industry. I am not so sure that that is true, particularly in the current political environment. But it is certainly true that strip-downs could be a useful tool to have when “future housing bubbles burst,” as they most certainly will.