Spiritually Bankrupt

As you can imagine given the mortgage crisis we’re in, almost all the clients coming in to see me nowadays are fretting about their homes.  A typical scenario is when the client has been set for foreclosure.  In Texas, the mortgage company has to give you 21 days’ notice before foreclosing, and the foreclosure can only take place on the first Tuesday of the month.  Given the mailing time, a property owner will typically get about two weeks’ notice – IF they pick up their certified mail (and yes, the foreclosure is still valid if you don’t pick up the certified letter!).  So I normally see clients who have about a week to go.  Their instinct is always to file an emergency chapter 13 case, stop the foreclosure, and propose a repayment plan to catch up on their payments and stay in the house.

Depending on their circumstances, this may be a good idea, or it may be a very bad idea.  The expenses and challenges of a Chapter 13 may set the client back further than a foreclosure.  I always ask the following questions to best advise a client whether to file a chapter 13 and keep the house or, alternatively, file a chapter 7, which would stop the foreclosure and give them a couple of months to move out while also discharging the mortgage and other debts.  In the Chapter 7 scenario, you don’t have to pay back what you’re behind, and you quite often get to stay in the house for three to six months (I’ve seen as long as two years) without making any payments.  Sometimes, though, even a Chapter 7 might not be possible or desirable, and I then advise them to explore other options: try to get time to sell the house, try to get the mortgage company to help them by modifying the loan or taking a deed in lieu of foreclosure, or even, rarely, to do nothing at all and let the foreclosure take place.

Here are the 3 kinds of questions I ask to determine whether someone should file a Chapter 13 case when they’re behind on their mortgage:

1. Can you afford this house?  If the reason that you’re behind on the mortgage is something extraordinary like job loss, illness, legal fees, a death in the family, etc.. and that circumstance has ended & you can now afford the house, you are or expect to be employed and have the ability to pay the current monthly payments on the house and a little extra to catch up on what you’re behind, then I would ask the following questions about your home.

2. Is there any equity in the home?  For me, this question means if you were to sell the house without putting any additional work in it, would you actually get any money?  If you are behind on payments and taxes, remember that these will be paid out of your share as well as closing costs, commissions, etc.

3.Is the house perfect for you?  Do you have young children who have grown up there and would be leaving school and friends?  Is it close to work?  Is it a safe neighborhood?  Do you have family nearby?  If the answers to any or all of these questions is yes, then staying might benefit you.  On the flip side, there may be reasons that you have to leave anyway.  Are you being transferred or laid off?  Do you have family you’d like to move to be closer to?  Does the house have any serious problems that need addressing – plumbing, foundation, roof, etc.?  Is it too small for your growing family?  If any or all of the answers to this second group of questions, then you might be better off letting the house go and filing a Chapter 7 instead of a Chapter 13.

The basic rule of Chapter 13 is “make your payments.”  First, you will have to re-start monthly payments to the mortgage company with the next payment due after you file bankruptcy (and the mortgage company is obligated to take it) and make every payment from there on in.   There is no negotiation – you pay your normal payment (though this may change with a provision Congress is seeking to add to the Bailout Plan – see my post on Mortgage Relief).  Second, your attorney will propose a plan to repay the mortgage arrearage with interest over three to five years.  The plan will also pay most of your attorney’s fees, any property taxes, recent income taxes, some portion of your credit card or other unsecured debt, etc. etc.  Additionally, there is an administrative fee of 10% per payment.

Take the scenario in which your house payment is $1500 a month, that your property taxes are about $5,000 per year and are not escrowed in your mortgage payment.  That gives you an effective payment of $1917 per month.  A month or a day after filing your Chapter 13 case (depending on whether you file at the beginning or the end of the month), you will need to pay a house payment and save towards your taxes (or your mortgage company may demand an escrow payment, particularly if they paid the last year’s taxes).  Let’s say that you were behind 6 months, which would be $9,000.  Add in the mortgage company’s attorneys’ and other fees and the last year’s taxes, that would be over $15,000.  Given your Chapter 13 attorney’s fees and the administrative fees, you would pay about $400 additional per month, giving you a $2,317 per month payment for your house alone for the next 5 years.  That means that over the next 5 years, you would pay $139,020 towards your home.

Now look again at the 3 questions above and ask yourself, is this amount worth it?  Think about what else you could do with that $139,020 over the next five years, particularly assuming you have filed a successful Chapter 7 and have no debt payments.  You would have to pay some rent for a few years, but that amount could be half or less than the $2,317.  You could save or invest the difference of almost $70,000.  If the answer to question 2 above is that there is no equity, then you have to ask whether your investment will create any equity and if so, how much.  Calculate that rate of return versus renting & investing the difference.  If in response to questions 1 and 3, you neither can afford the house and you don’t really need to or intend to stay there, then it doesn’t amount to much reason to keep the house despite an emotional attachment to it or fear of what happens once you give it up.  From that perspective, a Chapter 13 will often make no sense.  However, if you had a temporary hiccup in your finances, you and your spouse are now working and earning enough to easily pay for the house, and you have a decent amount of equity or plan to stay in the home for a long, long time, then Chapter 13 makes sense.

Remember that this is not meant to offer legal advice, but just to provide a jumping-off point for your decisionmaking process and your discussions with your attorney.