September 2011

In my last post I focused on housing because I think it’s the most important factor in the current mess.  This post discusses the programs set up to address the mortgage meltdown.  The feds also view housing as the linchpin.

I.          HAMP, HAUP, HAFA, HARP

These stand for “Home Affordable Modification Program”, “Home Affordable Unemployment Program”, “Home Affordable Foreclosure Alternatives Program”, and “Home Affordable Refinance Program”.

            A.        HAMP

Freddie Mac states:

HAMP is a loan modification program designed to reduce delinquent and at-risk borrowers’ monthly mortgage payments.  HAMP is effective for mortgages originated on or prior to January 1, 2009, and will expire on December 31, 2012.

Contractually the borrower agrees to repay the loan with interest according to the contract’s terms.  In modifying the loan, what is the borrower trying to do?  Some combination of:  lower the balance, lower the monthly payments, lower the interest rate.  The common theme:  the borrower wants free money. 

If a bank gives away free money it dies.  For example, if a bank has 100,000 mortgages and lowers the principal balances by $10,000, it loses one billion dollars.  If it lowers the payments by $500 each, it loses fifty million dollars a month.  The $500 figure is the Treasury Department’s standard HAMP monthly mortgage reduction.

Banks have an incentive to modify mortgages:

Servicers will receive $1,000-$1,500 for each eligible modification they establish, and a “Pay for Success” incentive of up to $1,000 each year for three years as long as the borrower does not become 90-days or more delinquent.

But this puny incentive won’t coax a bank into giving a borrower $10,000, or $500 per month, in free money. 
Continue Reading Home Mortgage Modification And Bankruptcy – Part II

I. The Classical Home Loan

At one time – sounds like a reference to the “olden days”, but it wasn’t so long ago – a borrower was expected to put 20% down as part of borrowing 80% of the purchase price of a home. The fixed monthly payment had two components: interest and principal. The interest was calculated as one-twelfth of the annual interest rate times the current principal balance. The principal was the difference between the monthly payment and the interest. Pretty simple. After thirty years of making the payments you owned the house. Things were a bit more complicated if the monthly payment included homeowner’s insurance and property taxes, but this was a minor adjustment to the basic idea.

II. The Community Reinvestment Act

The CRA was enacted in 1977. However, aggressive enforcement beginning in the mid-1990s sowed the seeds for the current financial problems. Why? It helps to know what the CRA requires. Yaron Brook of Forbes observed:

The CRA forces banks to make loans in poor communities, loans that banks may otherwise reject as financially unsound. Under the CRA, banks must convince a set of bureaucracies that they are not engaging in discrimination, a charge that the act encourages any CRA-recognized community group to bring forward. Otherwise, any merger or expansion the banks attempt will likely be denied. But what counts as discrimination? According to one enforcement agency, “discrimination exists when a lender’s underwriting policies contain arbitrary or outdated criteria that effectively disqualify many urban or lower-income minority applicants.” Note that these “arbitrary or outdated criteria” include most of the essentials of responsible lending: income level, income verification, credit history and savings history – the very factors lenders are now being criticized for ignoring.

Once the traditional lending criteria were jettisoned, banks started issuing mortgages to people who couldn’t put 20% down. These borrowers – we’ll call them CRA borrowers – had to borrow more than 80% of the purchase price. The larger loan meant a larger monthly payment, which was also a problem. The solution: option ARMs.
Continue Reading Home Mortgage Modification And Bankruptcy – Part I

I frequently have clients who owe back income taxes to the IRS or the Franchise Tax Board (FTB).  When these clients mention the taxes they tell me that they understand that tax liabilities can’t be discharged in bankruptcy.  While it is true that most tax debts are not dischargeable, there is a special carve-out in the Bankruptcy Code for cases filed under Chapter 7, 11, and 12, and Chapter 13 when the discharge is granted under 11 U.S.C. § 1328(b)  (the so-called “Chapter 13 hardship discharge” that is sometimes available to debtors who have not completed the plan).  As a convenient shorthand and a mild abuse of terminology, we’ll refer to this group of cases as the Chapter 7 case.

Things are slightly more generous if the debtor receives a Chapter 13 discharge under § 1328(a) after completing the Chapter 13 plan.  Unsurprisingly, we’ll call this the Chapter 13 case.  By the way, since all of the statutory references in this post are from the Bankruptcy Code, I’ll leave off the 11 U.S.C. and just give the section.

As you will see, timing is crucial.  Even one day off and the debt is not dischargeable.  Thus, as you read the post you will see how important pre-bankruptcy planning is in successfully discharging income tax debts.
Continue Reading Discharging Income Taxes: The Importance Of Pre-bankruptcy Planning

It is not news to say that today’s real estate market is terrible.  Many “homeowners” are quite literally hundreds of thousands of dollars underwater.  I put homeowners in quotation marks because someone who is underwater does not really own a single molecule of the house.

This leads many to surrender their houses as part of the bankruptcy process.  Surrender of the house can be very sensible if the debtor can’t make the payments, and has negative equity.  When the Bankruptcy Court grants the debtor a discharge, the personal liability on the mortgage is discharged.  Moreover, since the debt is discharged in the bankruptcy, there is no cancellation of debt income, so there is no adverse tax consequence to the surrender.  In addition, any prepetition homeowners association (HOA) dues are discharged because they were incurred prior to filing the bankruptcy papers.

However, postpetition HOA dues are not discharged in the bankruptcy because they are incurred after the filing of the bankruptcy papers.  See 11 U.S.C. § 523(a)(16).  In the current real estate market this unfortunate fact can create a real problem because if the debtor surrenders the property the lender is not required to take possession of it, or record a transfer of title.  In the vernacular:  you take force someone to accept a gift.
Continue Reading Homeowners Association Dues And Bankruptcy