This article first appeared in the St. Louis Beacon: July 22, 2008 - When all else fails and foreclosure looms, bankruptcy attorneys say give them a chance
Which is worse: Foreclosure or bankruptcy?
Sometimes, the rock can be better than the hard place, insist bankruptcy lawyers. It all depends on an individual's situation. And, they add, financially distressed consumers unable to negotiate a loan modification with their lenders might not think about bankruptcy as an option.
After reading the Beacon's coverage of the mortgage crisis, attorney Rory Ellinger of Ellinger and Associates of O'Fallon, Mo., suggested a story about how Chapter 13 bankruptcy can be used to stop a foreclosure.
Filing a Chapter 13 makes it possible for some families to stay in their homes, while homeowners attempt to catch up on back payments. The property cannot be seized during the 30 months the bankruptcy court gives the homeowner to "cure" the situation.
"It avoids costly and sometimes dishonest second mortgages that really can put a home even more at risk,'' Ellinger told the Beacon. "Most financial planners dismiss bankruptcy as an option, and they are usually wrong and simply acting out their middle-class values that bankruptcy is a sin or somehow dishonest."
Ellinger acknowledges that a Chapter 13 bankruptcy won't always be successful, but he believes that it should at least be considered before handing back the keys to a house. A Chapter 13 can be particularly effective for homeowners who have suffered a temporary setback -- most often due to job loss, a serious health issue or divorce -- but are now able to keep up with their mortgages and a court-monitored payment schedule.
Dan Claggett, managing attorney of the consumer unit of Legal Services of Eastern Missouri, said bankruptcy can be an effective way to stall foreclosure, which in Missouri can take just 60 days. Such a filing can also force into court an objection to a lender's practices, such as exorbitant fees. Legal Services does not file bankruptcies but will sometimes join in a case that is contesting objectionable practices by a lender.
Wendell Sherk of the St. Louis law firm Sherk and Swope said the negative stigma associated with bankruptcy can sometimes keep clients from acting in their own best interests because they are concerned about how their bankruptcy will be perceived by others.
"With foreclosure, there can be a sense of, 'I got taken by a mortgage broker, and it just made sense to walk away.' But with bankruptcy, they believe there is a certain moral failure that goes along with it,'' said Sherk, who writes about bankruptcy issues on the Bankruptcy Law Network blog, a forum by bankruptcy attorneys and consumer advocates.
The bankruptcy attorneys say much of the consumer information about the mortgage crisis is skewed toward the lending industry, which has a vested interest in keeping people out of bankruptcy court.
"I represent people going broke; I'm not going to have a large advertising program,'' Sherk said.
That said, both Sherk and Ellinger say the calls to their law firms from people seeking information about bankruptcies have skyrocketed.
Although bankruptcy laws are federal, nuances can vary by state, such as limits placed on exempted property. So, be sure you understand the rules specific to your state.
The Center for Responsible Lending, a nonprofit organization that fights predatory lending practices, has been lobbying for changes in the federal bankruptcy laws to allow court-ordered loan modifications for homeowners in bankruptcy.
Current law excludes the mortgage on a primary residence from being modified by the court. In a Chapter 13, even if other debts are renegotiated, the homeowner must continue to pay the monthly mortgage as set by the original loan agreement. In the case of a ballooning interest rate, a Chapter 13 might not offer the relief a homeowner needs. The organization estimates that court-ordered modifications could prevent 600,000 foreclosures.
The attorneys all caution homeowners against direct-mail scams that promise to bail them out of their financial troubles for a fee. How did the scam artists find you? Foreclosure notices are a matter of public record.
Here are some basic things you should know about bankruptcy, along with a disclaimer: This is not intended as legal advice. To learn more about bankruptcy laws, you can also read the book "Personal Bankruptcy for Dummies" by James P. Caher and John M. Caher. Excerpts are at www.dummies.com.
What is a Chapter 13 bankruptcy?
Think of Chapter 13 as a reorganization of debt, supervised by a federal bankruptcy court. For homeowners, the plus is that they can get up to 48 months to make up missed mortgage payments, while they continue to make current payments. And they get to stay in their homes.
A court-appointed trustee supervises a payment plan under which you make partial payments to creditors. You get to keep certain items, such as your car and furniture, paid for through your payment plan. You pay what those items are worth now, not what you owe on them. Unsecured debt, such as credit cards, is often dismissed.
Chapter 13 halts foreclosures, repossessions, garnishments, lawsuits and harassment from creditors.
Not everyone is eligible for Chapter 13. These bankruptcies are sometimes called "wage earner plans'' because they are usually granted to people who have some regular income, not necessarily wages from a job. If you can't keep up your court-supervised payment schedule, your bankruptcy can be dismissed by the court -- and you're back to where you started.
What is a Chapter 7 bankruptcy?
Think of Chapter 7 as the final surrender -- a liquidation sale. Many debts are wiped out instantly, though you are allowed to keep limited possessions. There is no repayment plan.
A Chapter 7 will wipe out most unsecured debt, including medical bills and credit card debt. Filing a Chapter 7 will halt a foreclosure only temporarily, and there is no opportunity to make up your missed payments by spreading them out. Chapter 7 is most helpful to homeowners who have little equity in their houses. They will lose their homes, but also their other debt. Some homeowners use a Chapter 7 as a chance to take a breath while they figure out their next step.
Will a foreclosure or bankruptcy ruin my credit rating?
At this point, the bankruptcy attorneys point out, your credit rating is already in ruins, so a decision between foreclosure or bankruptcy should be less about a credit score and more about the best way to land on your feet.
"What is a good credit rating? Credit is just the ability to go into debt,'' said Ellinger. "The sad thing is that people's lives are falling apart. Their credit's already in the tank, and all they're worried about is how will bankruptcy affect my credit?"
While it is admirable that people want to pay back their debts, Ellinger said that in some cases it just isn't realistic unless they get some relief.
Sherk said it is important for people to focus on regaining control of their lives.
While a credit report can reflect a bankruptcy for 10 years, most people will qualify for some loans after their bankruptcy is completed, Sherk said. But beware of those interest rates.
Foreclosures remain on a credit report for seven years and are of particular concern to mortgage lenders. In either case, the way to rebuild your credit score is through good money management.
And, remember, you are not alone. Three million American homeowners are facing foreclosure this year.
Who will know if I file for bankruptcy?
Though it is a matter of public record, the people who know about your bankruptcy will, in most cases, be limited to your creditors, your lawyer, the bankruptcy court and the court trustee.
Granted, this is all very embarrassing, but unless you're a celebrity, it most likely won't make the news, Sherk said.
How much does it cost to file?
The basic court fee is $274 to file a Chapter 13 bankruptcy and $239 for a Chapter 7. Attorney fees will vary depending on the individual case, with Chapter 13s costing more because they require more work.