Redwood Trust has announced that it recently sold a $222 million bond backed by jumbo mortgages.

Why do we care? Because since sometime in late, 2007, the jumbo market has been largely seized, with liquidity limited only to what could be sold to Fannie Mae and Freddie Mac.  But those two are limited to mortgages of less than $730,000, which means that lending liquidity for the so-called “jumbo product” has ben almost non-existent.  With median home prices in Marin County (usually) well above that amount, this has meant that financing for a significant chunk of the Marin market has been scarce as well.

Hopefully, this news is a harbinger of good things to come in the upper end of the Marin and other Bay Area markets.

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In a couple of other places in this blog I have discussed various components of California’s mortgage anti-deficiency laws. (See California Mortgage Deficiencies: What is a Purchase Money Security Interest? and Second Mortgages in California: Deficiencies Not Usually an Issue.)  This post will put it all in one place. At least the five basic rules.

I can’t warn readers enough, however, that these are very, very complex issues. I have–quite intentionally–over simplified them here, and I have done this to provide a precis on the big picture.  The case law interpreting the applicable statutes occupies volumes in California lawyers’ offices, and there are still many legal issues and questions that are unsettled.  So please go easy if I don’t answer your specific question here.  There is no way I can address all of the issues in one post, so if you have a specific question, please, post it in the comment section so everyone can see it, and I’ll do my best to answer it. But if you think you have a deficiency problem, or a possible exposure to a deficiency judgment, you really owe it to yourself to see an attorney who understands these issues. Also, bear in mind that the rules vary from state to state, so if you are reading this post with a real estate problem in any place other than California, you can be sure that the rules applicable to your situation are not the same.

First, what is a deficiency? Simply stated, a deficiency is what is left owed to a lender after the lenders forecloses and takes the real estate back. Example: If I owe $200,000, and the property is only worth $150,000 there is a so-called “deficiency” of $50,000. When can the lender come after the borrower for that “deficiency?”  That is the subject of this post. And, of course, in the current economy, a lot of people are trying to figure this out.

In California, there are four primary rules that apply. I discuss them below in no particular order.

1.  The One Action Rule. CCP §726(a).

The One Form of Action Rule basically says that the lender is required to chase the collateral first, and the debtor second…if it still can. A long, long time ago, a foreclosing lender could choose whether to foreclose on the collateral or go after the borrower personally for a money judgment. The one action rule of CCP §726(a) says that the lender must go after the collateral first, and, if it is legally possible, go after the borrower personally for any deficiency after that. Whether that is possible will depend on how the other rules set forth below kick in and apply to protect the borrower. But if you get sued on a promissory note and the lender is not a “sold out junior” nor taken hasn’t taken steps to foreclosure on the collateral, this rule would apply.

(I use the term “sold out junior quite a bit in this post. A sold out junior lienholder is the holder of a deed of trust that is junior to the first lienholder, and who has been denied a recovery due either to the foreclosure by the first lienholder, or because there isn’t enpugh value in the property to satisfy the junior debt after satisfaction of the senior debt. It is common for people to refer to such debts as “HELOCS,” but this isn’t technically accurate. A HELOC is simple a “home equity line of credit” that is secured by the subject property. It may be the most senior debt on the property or it may be a second, third…or tenth lien in order of its seniority. “HELOC” is a banking term; “sold out junior lienholder” is a legal term of art.)

2.   The Purchase Money Prohibition:  CCP §580b.

This is the best known rule and the one that applies more often than the others. If the loan that is being foreclosed on is a loan that was obtained for the purpose of purchasing the property, then no deficiency is allowed. It doesn’t matter if it’s a first, second or third.  It doesn’t matter if it’s classified as a “HELOC,” a “seller carry back,” or, ultimately, a “sold out junior.” Purchase money is purchase money. Example: Homeowner buys a house for $300,000, with a first for $200, and a second for $60,000, both put on the property at the time of acquisition. If the first forecloses, both lenders are barred from getting a deficiency because both loans are classified as “purchase money.” However, where the borrower has refinanced the original purchase money loan, or got a later home equity loan, that later loan is not a purchase money loan and could form the basis for a deficiency if the other anti-deficiency rules don’t otherwise apply.

But there is an exception to the exception: If the later loan was used to finance improvements to the property, then it can be a purchase money loan, and thus be a bar to a deficiency.

3.  The Non-Judicial Foreclosure, or “Private Sale Bar”:  CCP §580d.

This is the next most frequent rule. If the foreclosing lender has availed itself of the “power of sale clause” in the deed of trust, then no deficiency is allowed. Period. If they take the property back by means of a non-judicial foreclosure or trustee’s sale, then no deficiency. But unless one lender holds both loans, that only applies to the loan actually foreclosed on. Using the above hypothetical figures, though in this case making the second a non-purchase money loan, when the first forecloses, the holder of the first foreclosing loan is barred from seeking a deficiency both (1) Because it is purchase money, and (2) Because it has foreclosed by trustee’s sale. But the second, not being purchase money, and not being the one who foreclosed by non-judicial sale but having been wiped out by the foreclosure of the first, is not barred from pursuing a deficiency. In fact, in California, they have up to four years from the date of the breach of the contract to file a lawsuit seeking that deficiency.

And of course, as noted, there is an exception to the exception: If the holder of the first and the holder of the second are the same lender, and that entity forecloses on the first, it is also barred from seeking a deficiency on the second. This is important in California where lenders sometimes “stack” loans in order to get to a loan amount high enough to cover the high property values. It is also important to think about when the loans may have been sold to different lenders.

(On a historical note, CCP §580d was passed in light of the foreclosures and abusive deficiency judgments obtained by lenders during the Great Depression.  What we’re going through now is similar in many respects, though the ability of lenders to take the property and then chase the borrower who is already out of their home is limited by the passage of that statute. Small solace, to be sure, but it at least is doing what it was intended to do.)

4.  The fair Value Limitation: CCP 580aCCP §726(b).

This rule limits the amount of any possible deficiency to the amount by which the total debt exceeds the total fair value of the collateral. It only applies to deficiency judgments in judicial foreclosures, and, most importantly, it does not apply at all to sold out junior lienholders. Example: First mortgage of $450,000, and a second for $150,000, for total liens of $600,000. If the holder of the first forecloses and, it can be shown first at the time the first forecloses it can be shown that the property is only worth $400,000, then the foreclosing lienholder–on return to court seeking a deficiency–is limited to $50,000, regardless of what they sold the property for.  So if they pay a commission of 6% ($24,000, and additional closing costs of $5,000, that $29,000 is generally barred.  As for the holder of the $150,000 second? They can still come after the borrower for full payment, assuming, of course, such an action isn’t barred by one or the other of the above rules.

5.  The 3 Month Rule: CCP §580a.

This rule applies only in the case of judicial foreclosures. What’s that? Literally, it is a lawsuit in which the lender obtains a “decree of foreclosure” from a court–by definition not using the trustee’s sale procedure–and is unable to be made whole from the sale of the property. Example: Loan balance of $500,000. Lender obtains a “decree of foreclosure” from a court, after which it then goes out and sells the property for $400,000. In order to get a recourse judgment against the borrower for the $100,000 shortfall, that creditor must bring an action within 3 months of the sale date or it is barred.  An important carve out on this rule is that the 3-month limit does not apply to a sold out junior lienholder, the holder of the second in the above scenarios.

It is highly doubtful that you will have to deal with this rule without being fully aware of the issue steaming down the tracks towards you, simply because it can only happen in a judicial foreclosure. A lawsuit. As to whether or not you’ve been sued, well, you should know it. But check out my prior post Second Mortgages in California: Deficiencies Not Usually an Issue I referred to in my first paragraph above if you’re not sure.

As David Letterman would say, “please don’t try this at home,” by which I mean simply that if you are concerned that you may have a deficiency exposure, call a lawyer. A real estate lawyer, not a family lawyer, a personal injury lawyer or your Grandma Tilly’s trust and estates lawyer. This can be complicated stuff.

And last, of course, if the debt is discharged in bankruptcy, there is no deficiency at all. But that’s another post altogether.

Okay, so misinformation and confusion about the tax implications of foreclosure arising from the cancellation of debt seems to be piling up.  In particular, folks seem most confused by the receipt of Form 1099-A from lenders who have taken property back in foreclosure.

First, remember the basic principle:  Cancellation of debt MAY result in taxable ordinary income. [Note added 3/31/11:  The link is to IRS Publication 4681. This is a 2008 version of this publication, and that as I write this addendum note in March 2011, the IRS has not updated the publication.]

Second, because a foreclosure is viewed as a “sale of property,” if you let real estate go in foreclosure and it results in a cancellation of debt, then that foreclosure may be a taxable event.

There are three exceptions:

1.   First, if the property lost in foreclosure is a principal residence–literally the home in which you live–then the cancellation of the debt (“COD”) generally won’t be taxable.  This is a result of the Mortgage Forgiveness Debt Relief Act of 2007.

2.  Second, if your are “insolvent” at the time that the debt is cancelled (not at the time of the foreclosure, but more on this below) then you will not be taxed. Insolvency is a simple balance sheet test: If your liabilities exceed your assets, you are insolvent. Don’t over think it. You will have to submit IRS Form 982 with the tax return in the applicable year in order to demonstrate that insolvency.

3.  Third, if the debt is cancelled as a result of a bankruptcy filing, then there is also no tax. (This is one of the reasons I call bankruptcy “the ultimate mortgage modification tool.”)

(Follow the “more” tag below for the rest of this article…The really good stuff.)

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Most of my clients know that I am not a fan of Chapter 13.  This is mostly because I think that it keeps people in the bankruptcy process far too long (3 to 5 years), and that as a result, makes that “fresh start” promised by Congress so elusive. Nonetheless, there are times when it is either advisable or flatly unavoidable.

So here, without fanfare or editorial, is what the federal government would like you to know about Chapter 13.  Like my prior post on Chapter 7, it is simply a reprint of the information found on the United States Bankruptcy Court’s website.

Continue reading »

The California Homestead exemption (found in CCP §704.730 for those keeping track) was increased as of January 1, 2010.

The Homestead Exemption is the amount of equity in excess of existing liens that the homeowner can protect from levy by creditors.  So if your home has a value of $500,000, your existing mortgage balance is $400,000 and you fall into the $75,000 homestead category, then $75,000 of the $100,000 equity cushion in your home is protected from creditors.  This works in bankruptcy and out.

Here are the new limits:

  • $75,000:  Basic homestead for single person
  • $100,000:  Head of household
  • $175,000:  Over 65 or physically disabled or under 55 with less than $15,000 in annual income ($20,000 if married).

The full text of the statute appears below.

The exact numbers of the California Bankruptcy Exemptions will be released by the Judicial Council on or about April 1, 2010, and published by the Administrative office of the Courts.  The actual published limits are harder than hens’ teeth to find on line, even if you know what you’re looking for.  But here is the current published list of  California “Current Dollar Amounts of Exemptions from the Enforcement of Judgments.”  You can check back here on my site for an update when they release the new numbers on April 1, 2010.

California Code of Civil Procedure ("CCP") §704.730

May 11, 2010 UPDATE since original post:   60 Minutes with Morley Safer did a piece on Strategic Defaults on May 9, 2010 that you may want to check out.

Following on the heels of my post the other day on the Option ARM perfect storm that’s brewing in the San Francisco Bay Area, the LA Times recently ran a piece on the growing phenomenon of“strategic defaults”, by which is meant the intentional defaulting on a mortgage loan by a borrower despite an ability and the wherewithal to make the payments. In other words, just walking away.

Why would someone do this? Simple: The debt far exceeds the value of the collateral by such a margin that continuing to make the payments can no longer be justified by sound economics or abstract moralizing, guilt, sense of duty or any other non-economic reasoning. In other words, the numbers just don’t crunch any more.

The Wall Street Journal Economic Insight Blog also recently ran a piece on the subject in June, called “When is it cheaper to walk away?” The answer, according to the writers of that piece is 10%. When the balance of the loan is more than 10 greater than the value of the property, economically, it makes more sense to just walk away rather than keep making the payments.

The WSJ articles was, in turn, based on a very thorough paper prepared jointly by the University of Chicago School of Business and Northwestern’s Kellogg School (under the auspices of the Financial Trust Index). The paper, called WHEN HOMEOWNERS WALK AWAY: NEW RESEARCH REVEALS MORE THAN 25 PERCENT OF MORTGAGE LOAN DEFAULTS ARE STRATEGIC” concludes about 25 percent of foreclosures are “strategic,” meaning intentional and driven by larger economic considerations than merely the borrowers’ ability to make the payments, and that…

Homeowners start to default at an increasing pace, and walk away massively after decreases of 15 percent and more. In fact, 17 percent of households would default, even if they can afford to pay their mortgage, when the equity shortfall reaches 50 percent of the value of the house.

As for “strategic bankruptcy,” this is just the next step after the “strategic default.” (I wrote about this last year in an only-partially tongue-in-cheek “Top 10” list for why bankruptcy is the “ultimate mortgage modification tool.” I won’t repeat myself here.)

What does all this mean? Well, for one thing, it means that what we’ve known all along is now starting to attract the attention of economists and journalists.

As for what it might mean for an individual or family? Probably not much frankly. It seems to be giving an academic gloss to what people tend to know at a gut level anyhow: That we’re not out of the woods yet, there are lots more foreclosures and bankruptcies to come, and the housing market probably has a few more bumps in the road awaiting it before things smooth out.

As to whether this data or these reports can help you or anyone you know as you wrestle with difficult decisions: whether to default, whether to file bankruptcy, what other options you have, it probably can’t. Everyone’s situation is unique. Just like everyone else’s as the old saying goes. But before you decide that you’re going to “strategically default,” or file a “strategic bankruptcy,” you should consult bankruptcy counsel. There are lots of moving parts, and the amount of your home loan and the value of your house are just two pieces or a much larger puzzle.

Can you keep your car in bankruptcy?

On September 17, 2009, in Bankruptcy, Case Law, by David C. Winton

One of the most common questions that people considering filing for bankruptcy ask is whether they’ll be able to keep their car. The Ninth Circuit has recently–as in this week–changed the rules on that issue. The case is Dumont v. Ford Motor Company (In re Dumont), 9th Cir, 2009, No. 08-60002).

The answer now is:  It depends.

(For those unsure of what the Ninth Circuit is, it’s the United States Court of Appeal that has jurisdiction over Federal Courts in Alaska, Arizona, California, Washington, Oregon, Hawaii, Montana, Nevada and Idaho. Short of the US Supreme Court, it is the final judicial arbiter for legal issues and appeals in those jurisdictions. In other words, it has a lot of clout and if you live in one of those states, its decisions can affect you.)

The issue is whether a debtor in bankruptcy can keep a car which is subject to a loan agreement without expressly reaffirming the underlying debt. It used to be that the obligation would “ride thru” the bankruptcy case and stay in place–thus allowing the debtor to keep their car–as long as the debtor stayed current with the periodic payments. Dumont changes that. Or at least appears to.

Now, it seems that if you want to keep your car, the lender CAN compel you to expressly reaffirm the underlying debt. The key to that statement is that it CAN; it doesn’t have to and, frankly, it seems that in most cases, the lender wouldn’t want to force that because it might cause a debtor who is paying regularly, to have to give up their car. The lender doesn’t want your car; it wants your money.

In the Dumont case, the borrower continued making her payments on the car loan, but after the bankruptcy case was completed, and the debtor had obtained her discharge, Ford repossessed the car, even though she was current on the payments. (Why Ford would do something like that is beyond me, but there it is.)

In order to avoid this outcome, it would seem that the most prudent measure would be to reaffirm the debt in the bankruptcy case. I won’t get into the complexities of that process in this post, but suffice to say that reaffirmation is no guaranty of anything either.

(I have avoided the more technical discussion of the legal issues behind this holding, opting instead to provide the net-net outcome. Michael Doan, one of the lawyers involved in the Dumont case has written thoroughly and articulately on the topic here and for those interested in the nitty-gritty legal discussion, I would suggest going there.)

There’s an old saying: Beware of Greeks bearing gifts.  It refers to the Trojan horse that the Greek army used to trick its way into Troy during the Trojan War.  It has come to refer to situations and people that hide fraud and trickery behind a friendly and perhaps even generous demeanor.

The hottest new business in California?  One guess….  Mortgage modification.  Everyone and their brother is now opening up “mortgage modification” companies.   They appear friendly and eager to “help you save your home,” but be careful.

For instance, one I recently heard about is American Home Mortgage Servicing Company.  This company is not licensed as a real estate broker by the California Department of Real Estate. (If you want to check whether the company that is pitching you to modify your mortgage is a licensed real estate broker, use the DRE license check tool here.) Therefore, it is not a licensed “mortgage broker” and is thus not legally licensed to modify mortgages.  It is not a law firm.  It is not a non-profit credit counselor.  In fact, a little research reveals that it is nothing but a debt collector.  An unlicensed debt collector phishing for people with financial difficulties, which it refer to as “customers.”  (For reasons unknown, California doesn’t require debt collectors to be licensed any more.  It does, however, require them to comply with the California Fair Debt Collection Practices Act.)

Do what I did.  Call their toll free number.  Once you get past the language preference, the first thing on the tape is:  “American Home Mortgage Servicing Company is a debt collector and may record and/or monitor calls.”  Then, follow the various links on their website as if you are looking to modify your mortgage. You will eventually wind up on a form that you need to fill out and return to them. Do not do this. This form is designed to solicit highly confidential financial information from you which will, in all likelihood, be used against you in the event that you default on your mortgage.

There is no need to provide this information at this stage of the conversation with anyone.  (I’m a bankruptcy attorney subject to very strict rules of confidentiality.  I usually have very good reasons to request this information from clients.  Yet I never solicit this level of detail from prospective clients until they are an actual client and I have a rational and business-related reason for collecting this information.)  How do I know this isn’t a bona fide form for dealing with a mortgage modification? Look at it.  It doesn’t even ask who your lender is.  How are they going to modify a loan or provide you with advice and an opinion on the criteria required to modify the loan if they don’t know who the lender is?  (Lenders’ criteria for modification are not uniform, and a loan that one lender may modify may not qualify under another lender’s program.)

Here’s the fact:  No one has authority to modify your mortgage except you and your mortgage lender.  Anyone who claims to be able to assist you in modifying your mortgage but doesn’t ask who holds that mortgage right out of the chute is probably up to something very different.  Fortunately, these people tell you: They are “debt collectors.”   I wouldn’t give them the name of my dog without a written disclosure of who they represent, what they are actually authorized to do and a written representation from them as to what exactly is going to be done with the information I provide them. I suspect that if you call them and make this demand as a precondition to your giving them any confidential financial information, they will hang up on you.

Who are these people?  Are they licensed? Are they supposed to be?  Who’s regulating these guys?

In short, no one. It’s the Wild Wild West.  The California Department of Real Estate is supposed be on it, but in practical reality, it looks more like substitute teacher day in 5th Grade, erasers flying, tongues wagging, the whole works.  And who can blame the CDRE?  They’re overwhelmed.  So it will fall on the consumer.  If you try to do this without counsel, make sure that the person you’re dealing with knows what she is doing and that you’re protected.

Here are the rules, at least regarding licensing:

First, in order to function as a “mortgage modification company” in California the company must first be licensed as a “real estate broker” by the California Department of Real Estate.  (California does not have a separate licensing category for “mortgage brokers” nor for “mortgage modifiers.”) Modifying a mortgage is essentially the functional equivalent of originating a mortgage, so the same licensing rules prevail.  (Here’s an interesting opportunity to get a fly-on-the-wall ear to brokers talking to each other about this topic.)

Next, in order to collect any fee in advance for “mortgage modification” services, the entity must be licensed by the DRE and must submit its contract for services for approval to the DRE.  So if someone tells you they’re a “mortgage modifier” and wants you to pay them for providing those services, first demand their DRE brokers’ license number and then check the DRE website to see if their contract has been approved yet by the DRE.  If it hasn’t, then tell them you’ll pay them if and when they get a result for you.

[Update:  Effective July 1, 2009, it is unlawful for a foreclosure consultant, as defined in Civil Code Section 2945.1 to engage in the foreclosure consultant business unless it has registered with the Attorney General’s Office at:  http://www.ag.ca.gov/register.php. All foreclosure consultants operating in California must post a $100,000 bond and register with Attorney General’s Office by July 1, 2009.  There is list of companies whose agreement has been approved. It’s very short. You can find it on this rather hard to find site called California Foreclosure Prevention Act.   There is also a list of companies that have not been approved by the Attorney General, although that strikes me as sort of foolish.  Given that scam artists work pretty hard to cut a low profile, its a bit like saying “raise your hand if you’re not here.”]

American Home Mortgage Servicing is not on that list.  American Home Mortgage Servicing is also not a licensed real estate broker in the State of California.  In fact, American Home Mortgage Servicing does not appear to be licensed to do anything more complicated than exist in the State of California.  And it’s a Delaware corporation so it’s not even domiciled here.  (Debt collectors no longer need to be licensed in California.)

(Here’s a link to the California Attorney General’s recent online posting about how to avoid being ripped off by foreclosure rescue scams.   And here’s another article/consumer warning by the DRE about scams offering to “cut your home payments in half.”)

There is a growing number of unscrupulous people out there right now looking to take advantage of people who are in financial extremis.  There are also tons of folks who, while maybe not slimeballs, are woefully unqualified to “modify” anything more complicated than a typo on a spelling test.

Current statistics suggest that only 5% of the people who attempt to modify their mortgages are actually succeeding right now, and of those? More than 50% re-default in the first 6 months!  I’m not going to blame all of that on slimeballs and idiots, but I can’t think of any argument that suggests that the presence of opportunistic and unscrupulous slimeballs and idiots posing as “mortgage modifiers” is helping matters.

But there are also a lot of good, qualified and experienced people who want to help, who charge a reasonable fee and who know what they’re doing.  (And I absolutely guarantee you that they don’t refer to themselves on their voicemail as “debt collectors.”) Some are mortgage brokers, some are attorneys, some are credit counselors.  None are debt collectors.   Look for non-profit credit counselors as a start.

I’m not suggesting that everyone who wants to investigate mortgage modification hire an attorney. But at least do a little homework and make sure the person or company you hire is qualified and licensed.  If they disclose that they are “debt collectors” run the other way.  Such people have nothing of value to offer you.

Now, I don’t mean to be overly flippant or anything, nor to be accused of promoting “irresponsible behavior” by advocating that people walk away from valid and legitimate debts, but I have to say that the single most effective “mortgage modification” tool for most borrowers these days is found the United States Bankruptcy Code.

So here–with a nod to Letterman for borrowed style points–counting backwards from 10 to 1, are the Top 10 Reasons why, more often than not, I advocate filing a bankruptcy petition instead of incurring the brain damage of trying to deal with banks.

(Lawyerly or, the obligatory “all things being equal” caveat:  This is true in many, but not all cases, and I’m assuming that the borrower has a fair and real choice between these two options.  Like with ANY legal remedy, it has to make sense for your particular circumstances, and, of course, the numbers have to crunch.   Bankruptcy is a technical and specialized area of law, so the decision should be made neither lightly, nor without expert guidance.  Things may also change over the coming months when–or more accurately, if–the lending industry gets its “mortgage modification” act together and actually raises their success ratio to something more respectable.  As it is now, in some areas, the default rate is as high (around 5%) as the “mortgage modification” success rate is low.  That’s a disgrace.

Anyhow, on with the Top 10 List.

10.    Bankruptcy doesn’t require you to bare your soul to some faceless, nameless banker only to have them tell you you’re not “qualified” for their mortgage modification program.  Of course, this is inane to start with:  If a borrower was “qualified” for the unaffordable, predatory loan that got them into the dilemma in the first place, how could they not be “qualified” for something more affordable now?   This is “bank logic” talking.  And it’s “bank logic” that caused this mess to begin with.  Arguing YOUR personal finance with a banker is like arguing about Halloween candy with an 8-year old. Generally, you can’t win this argument so why have it?  (For an absolutely classic example of this  absurd paradigm in action, check out this story on MSNBC.)

Recent reports suggest that only about 5% of attempted mortgage modifications are actually succeeding.  Success being defined as a negotiation that concludes with a new, supposedly more affordable mortgage. What about the other 95%?

First of all, the bank has probably squeezed another few months of interest payments out of the borrower as they strung them along leading you to believe that your “application” for a modification was being seriously considered.  And second, all the information you worked so hard to assemble for your banker will now to go into your “file,” to be used for who-knows-what-purpose.  Since I’m a lawyer, I’m paranoid by habit and profession.  I assume it goes into storage to be be puled out and used against you later when when the bank decides to sue you for a deficiency.

9. The lender doesn’t get a vote.  Generally, if you file a bankruptcy petition with a goal being to jettison a burdensome and onerous mortgage, barring something going seriously awry, you’re going to achieve that goal.  No matter what the bank has to say about it.  In the vast majority of cases, they don’t get to vote.

8. Bankruptcy is faster and will get you back on the road to financial recovery much faster than a bank sponsored “mortgage modification.”  Chapter 7 can be over and done with in as little as 3 to 4 months.  Chapter 13 can have you in an affordable payment plan even sooner.  In order to even qualify for a “mortgage modification” program right now, in most instances, you need to be at least 60 to 90 days delinquent before they’ll even talk to you.

Then, after you’ve prostrated yourself on the altar of some Loan Modification Committee of Third National Bank of Timbuktu trying to get a modification approved, or worse, had to deal with some newly minted “loss mitigation specialist,” you are likely to wait for another 3 to 6 months for any word.  Why?  Because they are up to their eyeballs in “loan modification requests” and they are noteager to make those painful modifications.  Banks are not modifying loans because they think it’s a good idea; they’re doing it because they have no choice.  But if they can suck a few more months of interest out of you then, in the bankers’ logic, they’re making lemonade out of lemons. It’s a get-what-we-can-while-we-can mentality.  If your financial statement leads them to believe that you’re a likely Chapter 7 candidate anyhow, it’s in their best interests to recover as much as they can before that happens.

7.     It’s (probably) cheaper.  This is a hard one to be sure of, but if you hire an attorney (or worse, one of these new “loan modification companies” that are popping up like weeds these days) to try to assist you with a mortgage modification application, and then pay him or her to run all that interference for you, your final bill is likely to be significant.  (And don’t shop for a mortgage banking/loan workout lawyer based on the low bidder.  You get what you pay for in the legal profession and there aren’t a whole lot of low cost lawyers who understand the law of mortgage and real estate finance.  (Mortgage, bankruptcy and insolvency law is not a first offense DUI or uncontested divorce where pretty much anyone with a bar card can get you through the process.  In banking law you get what you will get what pay for.)

In bankruptcy, most attorneys charge a fixed fee for taking the client all the way through the process, and those fees are subject to the approval (and possible adjustment) by the Bankruptcy Court.  Filing fees are relatively cheap, at present, $299 for a Chapter 7 and $234 for a Chapter 13.

Paying an attorney to try to get a home loan modification approved is tantamount to handing over a blank check.  As much as I love my profession and trust in the utmost integrity of my fellow members of the bar, only a fool gives a lawyer a blank check.

6. You don’t have to talk to any bankers.  Nothing personal to any of my banker readers (as if) but dealing with bankers is only slightly less painful and irritating than a root canal.  Contrary to what you may have heard, bankers don’t care about you.  Their job is to lend money and maximize their company’s return on investment, or, in this economy, minimize loss.  Converting an asset that is returning 8.5% interest into one that only returns 6.5% is going backwards.  Bankers created this mess.  I don’t believe it’s realistic to believe that they’re going to be the ones to fix it.

5. When bankruptcy is over, it’s over, and it feels very good.  Mortgage modifications are forever.  Or until you default again.

There is no doubt but that, in addition to the day they graduated from college, the day they were married, and the day their first child was born, other Red Letter Days in the lives of people who have endured financial stresses severe enough to make them consider bankruptcy, include the day they got their discharge and emerged from bankruptcy.  It’s like the relief one might expect to feel when you stop banging your head against a brick wall.  In my experience, I’ve never heard anyone who relieved themselves of mountains of unmanageable debt say they wish they hadn’t filed.  What I hear is that they wish they hadn’t waited so long.

4. You can’t get scammed by a bankruptcy court that’s giving you relief from the guy who scammed you in the first place.  LoanSafe.org is reporting that “loan modification scams” are one of the hottest new consumer ripoff industries.  I suppose they take a lot of different forms, but be careful.  At least lawyers have to be licensed, bankruptcy fees are subject to the supervision of the court, and loan modification scam artists generally don’t hang around in Federal court rooms wearing black robes.

3. The Bankruptcy discharge is forever.  More than half of mortgage modifications are headed for another default.  What do I mean by this? Well, first of all, a little background, and if you don’t want the background, skip the next paragraph and race to the “payoff.”

One of the Federal government’s official keeper of mortgage statistics is the Office of Thrift Supervision, known–as with any self-respecting government bureaucracy–by its acronym OTS. (OTS is a wholly owned subsidiary of the US Department of Treasury for those keeping track.)   Every quarter, OTS releases its “Mortgage Metrics” report, which is a 25 to 30 page impenetrable tome of economic gobbledy gook.  If you don’t believe me, here’s Q1 2008 and here’s Q2 2008.

Now the payoff:  The Mortgage Metrics Q3 2008 report will, when it is released, report that 53% of all mortgages that are modified wind up back in default.  This is what is being reported by sources that have seen it, or at least talked to people who have seen it.  My source?  MortgageDaily.com.

2. Bankruptcy is less stressful.  Financial fear and worry is one of the worst sources of stress that we can suffer from.  It’s only exacerbated when the cause of that stress is also the very roof over our heads.

1.     When it’s over, you get a REAL fresh start.  Bankruptcy is a financial reboot.  A whole new day.  Yes, if you are successful in completing a loan workout with your lender, there will be relief. Probably substantial relief.  But you also don’t get to start a rebuild, or get rid of other debts and liabilities that may threaten to drag you down again later.  If your oppressive mortgage is your only financial woe, then you may get some real relief from a mortgage modification attempt.  But those sorts of problems are not usually so isolated.

Again, I don’t mean to sound flip, nor to minimize the impact of having to file bankruptcy.  But if you are able to do so, and if your mortgage is only one part of a larger scheme of financial woes, what better way to “modify a mortgage” than to get rid of it?  Of course, this means that you will also lose the property, but in most of the cases that I’m reviewing these days, that isn’t a priority anymore. When the loan is $750,000 and the house is worth $600,000, what’s left to save?  (Those are Northern California numbers; your examples may vary if you live in other parts of the country.)

Upshot:  Know your options before you dive into a process that may not do as much for you as you hope it will.