Bankruptcy Offers Options to Resolve Delinquent Credit, Past-Due Mortgages

The flagging economy has forced many Americans, who never expected to be in that position, to consider bankruptcy. As housing prices tumble, unemployment passes 8% for the first time in a quarter century, investments falter and credit tightens, thousands of people that were recently financially secure or even well-off now face home foreclosures, past-due credit card accounts and a struggle to make ends meet. Bankruptcy filings are on the rise. Good financial planning now requires a working knowledge of the different options for bankruptcy relief that are available.

Chapter 7 is what most people think of when they think of bankruptcy. The simplest form of relief, Chapter 7 cases are the easiest to file and require the least amount of participation by the consumer. A set of papers known as "schedules" are prepared which list information about the consumer's financial situation - debts, property, income and expenses. After completing credit counseling the schedules and a brief petition, containing primarily identifying information about the consumer, are filed with the court with a $299 filing fee.

As soon as the petition is filed creditors are prohibited from taking any action to collect a debt from the consumer. This "automatic stay" of collection actions prohibits mortgage foreclosures, repossessions, wage garnishments and even telephone calls to the consumer. A trustee is appointed to gather and sell any non-exempt property of the consumer that can be sold for creditors. The tricky part here is that only non-exempt property can be sold by the trustee. Each state has a different set of property exemptions - property that is protected from the trustee. You should consult a knowledgeable bankruptcy attorney to analyze your exempt and non-exempt property. In most Chapter 7 cases no property is taken from the consumer by the trustee.

Approximately 30 days after the case is filed a "meeting of creditors" will be held. The consumer appears at the meeting which is conducted by the trustee in a meeting room rather than before the court. The trustee and creditors have the opportunity at the meeting to ask the consumer questions about their finances. In most cases this is the only time the consumer will have to be present. The process is usually over in about 45 days.

In return for turning over any non-exempt property to the trustee for the benefit of creditors, the consumer receives a forgiveness, or "discharge," of most of their debts. Some debts cannot be discharged, such as child support, alimony and domestic property settlements, and others, including taxes and student loans, are only dischargeable under certain circumstances. The advice of an experienced bankruptcy attorney should be obtained to determine which debt will be discharged.

While Chapter 7 bankruptcy delays a home foreclosure for a short period of time, it does not provide a way for the consumer to put their mortgage back on track and stay in their home. The best bankruptcy option for curing a mortgage default is a Chapter 13 case.

The procedure for starting the Chapter 13 case is very similar to Chapter 7, but with a $25 discount on the filing fee. Instead of surrendering non-exempt property to the trustee, as in Chapter 7, a Chapter 13 consumer retains their property and promises to pay their disposable income (income after normal living expenses) to the trustee for three to five years. In return, the Chapter 13 filer also receives a discharge of most debts.

The Chapter 13 filing not only stops the foreclosure on the home mortgage, but allows the homeowner to propose a simple plan for resolving their delinquency. Although it provides a means for curing the delinquency, the plan cannot currently modify the terms of the mortgage obligation, such as the interest rate, amount owed or length of the payment term. But on March 5, 2009, the U.S. House of Representatives passed a bill (H.R. 1106) which would permit bankruptcy judges to either reduce the amount owed or the interest rate on a home mortgage. A typical cure method under current law would be to pay the past-due amounts over a number of months through slightly larger mortgage payments.

Chapter 13 offers the best bankruptcy option for putting a delinquent mortgage back on track. However, not everyone will qualify for this type of relief. Consumers with mortgages and other secured debt totaling more than $1,010,650, or unsecured debt of more than $336,900, will not be eligible for Chapter 13 and will have to file a Chapter 11 case to obtain similar help. Unfortunately, the Chapter 11 process is far more complicated and costly than Chapter 13. The $1,039 filing fee is just the beginning of the higher costs under this chapter, which was principally designed for business reorganizations. The increased cost provides no better relief. While delinquencies can be cured over time, the basic terms of the home mortgage cannot be altered. Chapter 11 relief for the individual should only be considered as a last resort.

Sources:

Riechmann, Recession On Track To Be Longest In Postwar Period, (Associated Press March 8, 2009), http://biz.yahoo.com/ap/090308/the_worst_recession.html

The Administrative Office of the U.S. Courts, http://www.uscourts.gov/bnkrpctystats/bankruptcystats.htm

U.S. Bankruptcy Code, Title 11, United States Code, available at http://www4.law.cornell.edu/uscode/11/

http://www.bankruptcyaction.com/bankruptcyexemptions.htm

http://www.uscourts.gov/bankruptcycourts/fees.html

Mortgage Cramdown Debate Moves To The Senate, American Bankruptcy Institute (March 6, 2009), http://www.abiworld.org/AM/Template.cfm?Section=Bankruptcy_Headlines

http://www.govtrack.us/congress/bill.xpd?bill=h111-1106