FOR SOME, THERE’S NO WORSE FATE THAN losing a home to foreclosure.
They would opt for anything — even bankruptcy — if they could hang on to their home.
That was true of Chicagoan Carla West, a bankruptcy success. A military veteran, West says, “I made a couple of really bad decisions” that put her behind on her mortgage and other bills.
A Chapter 13 filing in 2002 dictated that she pay $750 a month to catch up, in addition to her regular bills.
“I knew that if I defaulted on my mortgage, I could never qualify for another VA [Veterans Administration] loan,” recalls West. Besides, “I made the decision that I wanted to save my house.”
Though not the only option for the payment challenged, bankruptcy — especially Chapter 13, or the “home saver” — is confusing to the typical consumer, says Chicago bankruptcy attorney David M. Siegel. Federal bankruptcy reform enacted a couple of years ago only adds to the problem, maintains Siegel, who says more distressed homeowners should go this route to prevent foreclosure.
Indeed, a bankruptcy filing can halt the foreclosure action, and borrowers who complete a workout of their debts as mandated by the bankruptcy court can remain in their home.
But while bankruptcy can be a road to redemption, it’s a path strewn with obstacles, says Jay Guo, a director of asset-backed securities research at Credit Suisse, New York, and lead author of a recent report on bankruptcy and foreclosure titled: “[Subprime] Heat Hot Topic: More Repay Plans Fail in Subprimes Under the 2005 Bankruptcy Law.”
Historically, only about one-third of Chapter 13 filers successfully navigate the years of debt-payback it carries and emerge from the process with their home, the report showed.
For the rest, foreclosure is often re-initiated. This happens to many subprime borrowers, who Guo notes are generally ill-equipped to succeed in bankruptcy workouts.
For some in arrears on their mortgages, there may be better options than bankruptcy. A workout directly with the lender — extending the loan term to lower monthly payments, for example — may be possible. In some instances, borrowers may have a mortgage made illegally — a negotiating point for new terms or a settlement.
David Yen, supervisory attorney of the bankruptcy project at the Legal Assistance Foundation of Metropolitan Chicago, says homeowners should seek help as early as possible. He lists Chicago’s 311 non-emergency line or neighborhood groups as places to start. Counselors can help negotiate with mortgage lenders, and may also be able to point to local emergency funds for distressed homeowners.
That can keep them out of bankruptcy, says Yen.
It also can give them a leg up on the bankruptcy reform rules that mandate that individuals receive credit counseling before beginning the process. “If credit counseling is going to be helpful, why wait until the last minute to get it?” Yen asks.
With an earlier start, a smart counselor can identify who is a good candidate for a bankruptcy or provide other suggestions, including that the home is impossibly expensive and best handled with a quick sale, notes Yen.
The more homeowners know about bankruptcy, the better their chance of success, financial experts agree.
Individuals can file a Chapter 7 or a Chapter 13 bankruptcy. The latter is called the “home saver” because it gives the owner some time to catch on overdue mortgage payments and fees, while making his current payments.
A Chapter 7 filing, however, doesn’t provide for repayment of a mortgage, says Siegel. Instead, it may allow financially strapped homeowners still current on their mortgage to discharge some unsecured debt, like credit card bills.
The recent bankruptcy reform raises the bar on who can qualify for a Chapter 7 fresh start, however. Only households that meet a “means” test can see lots of debt forgiven. In Illinois, a family of four can have a household income no greater than $74,705, or have a level of allowable expenses and secured debt that still qualifies them, notes Siegel.
Moreover, in Illinois, Chapter 7 filers can keep no more than $15,000 in home equity (married owners can keep $30,000); people with home equity above the limits aren’t appropriate candidates for Chapter 7, since the court can force a sale so that surplus equity can be paid to creditors, Siegel said.
Even with the catch-up feature of Chapter 13, only a minority of filers are able to start meeting payments. Besides what they owe their creditors, the workout usually includes gradual payments to a bankruptcy attorney, notes Siegel.
It took West’s military resolve to succeed: “I had to change my entire life. I didn’t go out to night clubs or restaurants. I gave up drinking and hardly bought anything new.”
But by 2005 she completed her rigid regime, has since kept from racking up credit-card debtances and boasts a credit score of 700.
Of course, even the “successes” suffer damaged credit, impairing their chances of qualifying for future credit or other products such as insurance. It can even hurt your chance of getting a job, since some firms check job candidates’ credit records.
“It’s hard to say which will impact your credit score the worse — a foreclosure or a bankruptcy,” says David Chung, vice president of CreditXpert Inc, a Towson, Md., firm that provides personal credit analysis.
“Someone who has good credit who files for bankruptcy or has a foreclosure might expect their credit score to immediately drop by 100 or 150 points,” Chung says. But “if you miss three mortgage payments, for example, your credit is already sunk. The foreclosure is just another incremental stain.”
It’s often easier to boost a score after a bankruptcy than after a foreclosure, adds Chung. That’s because some people can whittle down the credit-card balances in the bankruptcy process, which can lift a score. But scoring is so individual, it’s impossible to make blanket statements on the effect of a foreclosure or bankruptcy, he says.
In the current climate, lenders are wary of borrowers who have lost their house in a foreclosure. In the mortgage boom just a couple of years ago, it was possible to find a subprime mortgage lender who would extend a loan to someone relatively fresh out of a foreclosure, notes Bud Frase, president of Hometown Mortgage, a brokerage that specialized in subprime loans, in Libertyville.
Now, with all lenders tightening their standards, it’s anyone’s guess how much time needs to elapse after a foreclosure before you can find another mortgage, says Frase.
If a borrower who has experienced a foreclosure wants a competitively priced, conventional [not subprime] mortgage, it can easily take at least four years from the foreclosure until he can qualify for such a loan, says Tony Garvy, president of American Mortgage Specialists, Glen Ellyn. Even then, “he’ll need a good credit score.”
For borrowers with a bankruptcy or a foreclosure on their record, it now generally takes four years of good credit habits before they can qualify for a conventional loan, confirms Brad German, spokesperson for Freddie Mac, one of the government-backed agencies that makes loan rules.
But in some cases, they may be able to secure a loan after two years if they can document that the foreclosure or bankruptcy was due to a specific circumstance, says German.
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