President Obama has announced his support for several changes to existing bankruptcy law. These changes should assist those people who have been caught-up in the economic turmoil that is now referred to as â€œthe Great Recession.â€ The changes are also aimed at stemming the tide of foreclosures throughout the country.
On February 18, 2009, the President announced his plan to rescue families who are facing foreclosure as a result of the current economic downturn. During the press conference in Arizona, the President discussed not only his plan to help homeowners, but referenced his support of legislation in Congress right now â€“ the â€œHelping Families Save Their Homes Bankruptcy Act of 2009.â€ The act is discussed below in this article. One additional comment which escaped most observers was the Presidentâ€™s statement that one of his administrationâ€™s goals was to reform bankruptcy rules to make seeking bankruptcy relief easier for individuals. Perhaps this signals some revisions to the Bankruptcy Abuse Prevention and Consumer Protection Act (â€œBAPCPAâ€), a set of rules implemented on October 17, 2005 â€“ primarily at the urging of the credit card companies. BAPCPA has been widely regarded as a complete failure by industry experts as it has not accomplished its goal of preventing abuse and protecting consumers. Instead, the Act has been criticized for only causing more backlogs in the courts, and not addressing the true sources of abuse in bankruptcy. Although specifics have not been announced, the hope of many is that the changes made in 2005â€™s BAPCPA will be revised or scrapped all together.
Bankruptcy Help for Homeowners.
Presently, the rules governing the treatment of a Debtorâ€™s (someone who files bankruptcy) home donâ€™t provide a great deal of help to someone facing the loss of a home. In yearâ€™s past, Chapter 13 bankruptcy was seen as a good tool for someone who had fallen behind on their mortgage because of either unanticipated catastrophic expenses (uninsured health costs, or otherwise) or because of a temporary loss of income. In that case, Chapter 13 allows the Debtor to (1) stop a pending foreclosure, and (2) repay the past-due amounts in their Chapter 13 plan over 3 to 5 years. In years past, this remedy was deemed sufficient because a large number of debtors only experienced a temporary setback in their ability to pay their mortgage on time, and they eventually returned to pulling down sufficient income to continue paying their mortgage. Chapter 7 bankruptcy offered little assistance to a Debtor with a home in foreclosure, except that the Debtor could abandon the home, and avoid any potential deficiency he might owe the lender (the difference between his mortgage and what the bank recovered in foreclosure). Again, in some circumstances, this was a useful tool, but the application today is somewhat limited.
Why Is Change Needed?
Change in the Bankruptcy Code are needed at this point because the crisis in homeownership faces challenges that just didnâ€™t exist even 10 years ago. The emergence recently of so-called â€œcreativeâ€ mortgages has created an entirely new set of problems that just cannot be addressed under the existing bankruptcy code. Take a homeowner who bought a house with little down, and utilizing something called a 2-28 ARM mortgage. The 2-28 Adjustable Rate Mortgage (ARM) was created by the home mortgage industry as a means of helping people get into homes, with the idea that within two years after they bought the home, they could either refinance into a fixed-rate mortgage, or their income would increase sufficiently to allow them to continue paying the mortgage. For the first two years of the loan, the payment is based upon a low, fixed interest rate referred to as a â€œteaserâ€ rate. At the end of two years, the mortgage â€œadjustsâ€ up to a new rate determined by the loan documents, and from that point forward for the next 28 years, the loan interest rate adjusts regularly. The problem is that initial adjustment upwards could mean the base mortgage payment at the end of year two could increase 50% or more. As we all now know, the ability refinance many of these loans vaporized as home values fell dramatically beginning in 2007, and many of these borrowers now owe more than the house is worth.
Another â€œcreativeâ€ mortgage is referred to as the World Savings Pick-A-Payment loan. The reference to World Savings is due to the fact that a large majority of this type of mortgage was offered by World Savings Bank. In a â€œPick-A-Paymentâ€ mortgage, the borrower had the option of making one of four different payments in any given month. The idea was that by giving the borrower options, they could make more aggressive payments when finances were good, and had the option of making lower payments in leaner months. In theory, this would be a great loan for someone who is self-employed, and cannot predict their cash flow monthly. In reality, few people are disciplined enough to pay more when they can. Many homeowners either couldnâ€™t, or didnâ€™t elect to make anything more than the minimum monthly payment, which is in fact a negatively-amortizing payment. That means that every month, the payment isnâ€™t enough to cover the interest accruing on the loan, so the loan balance is actually going up. This, combined with the fact that many of these loans were 95% or more of the value of the home when purchased, means that very quickly, people were in a position of owing more than they paid for the home, or more than the home was worth. At the point where the loan balance reaches 120% of the original loan amount (in other words, a few years after making nothing but the first, lowest payment option), the lender exercises its option to force the homeowner to now make fully-amortizing payments. This increase, as with the adjustment in the 2-28 ARM loan, caught many homeowners in a position of not being able to make their mortgage payment.
As discussed previously, the existing Chapter 13 remedies do not allow for any change in the basic loan terms. The 2-28 ARM is still going to be a high, adjustable interest rate during and after the case is commenced. The fully-amortizing pick-a-payment loan is still not going to be affordable to the borrower. As such, there is a need in bankruptcy to allow a judge to modify the Debtorâ€™s mortgage in a way that will make it affordable, and feasible for the Debtor going forward post-bankruptcy. This is fair to the homeowner and the banks as the banks put people into a position of guaranteed failure, and should share in the solution. H.R. 200: the Helping Families Save Their Homes In Bankruptcy Act of 2009 attempts to bring the Bankruptcy Code and Courts in line with one of the biggest problems facing our nation today. A failure by Congress and the President to enact this law will certainly guarantee that our economy will remain in turmoil for years to come, and will force the housing slump into a deep, dark place nobody wants to see. In a follow-up article, I will cover some of the specifics of the Act as it stands right now.
David L. Gibbs is an attorney with The Gibbs Law firm, APC. The firmâ€™s practice focuses on issues related to Bankruptcy, Business Law and Manufactured Housing; including community subdivision, pre-purchase diligence and analysis as well as advising community owners on operational, financial and enforcement issues. The firm also represents manufactured home dealers in a wide range of issues. David L. Gibbs is admitted to the Federal Courts for the Central and Southern District of California, and also holds a California real estate brokerâ€™s license. The firm continues to offer a wide range of real estate and business related services as it has done for 34 years from its offices in San Clemente. Mr. Gibbs can be reached at (949) 492-3350.