As this dog-tired economy continues to drag on, with no relief in sight and no bounce-back in home prices appearing anywhere on the horizon, the single question I am asked most frequently is “Should I walk away from my mortgage, and if I choose to do that, what are my options?”
Usually it comes in the following form. “We bought our house in 200_, for $_______. It’s now worth less than what we paid, and less than the outstanding loan amount. We’re considering our options, but are not sure what to do.”
Sometimes this question comes up because someone has lost a job, or is in the real estate business and hasn’t been able to generate much commission income in the past 2 to 4 years, although sometimes it’s just the economics themselves that trigger the inquiry.
The question about what to do, however, is less a legal decision than it is an economic decision. Of course, once you decide to walk away, then the follow-through becomes a purely legal act, and should only be undertaken after consulting with legal counsel and obtaining a full understanding of what is likely to happen.
First, should you? That all depends on where you think housing prices are going to go in the future, how long you’re willing to tough it out and what your other housing options look like. Obviously, you have to live somewhere, so if you’re not going to own, then you have to have a good understanding of what your rental options are Example: A family of four, with two teenagers, living in a 1,500 square foot house in an expensive neighborhood is going to be looking at a very different set of concerns than a childless couple living in a 4,000 SF home in an affordable location. That seems obvious, but to many folks it apparently isn’t.
So it’s not a straight dollars and cents analysis. Just because your home is worth 20% less than the balance on your loan, no lawyer can advise you on whether you should keep the house and keep paying, or let it go and brave the consequences. All a lawyer can do is tell you what is likely to happen under any particular course of action.
Next, if you do decide to walk away, what is going to happen? Well, we all know that such a decision is going to cause significant credit problems. It’s inevitable: If you walk away from a home loan, your credit is going to suffer. But what else?Fortunately, we don’t have debtor’s prison, so despite the loss of the house to foreclosure–another inevitability although the timing may vary depending on circumstances–you may get sued. Obviously that’s no fun, and is something that you should try to avoid, but whether that is likely to happen or not is a very good question to take up with a lawyer. We’re lucky in California as there are very powerful anti-deficiency laws, about which I have already blogged rather extensively. (See California anti-deficiency rules and statutes: When can a mortgage lender in California recover a deficiency after foreclosure?, California Mortgage Deficiencies: What is a Purchase Money Security Interest? and Second Mortgages in California: Deficiencies Not Usually an Issue for full treatment of the subject.)
Last, what about staying and trying to complete a mortgage modification? I’m sorry to say that I’m a cynic on this subject. The process seems capricious and arbitrary at best, and since my experience leads me to the unshakable and firm conviction that, as a class of people, consumer bankers are among the dumbest clowns wandering the planet, the percentage likelihood of any one homeowner or family successfully completing a mortgage modification is nearly microscopic. This is especially true here in Northern California where incomes and home prices are among the highest in the country. They’re not much interested in modifying mortgages for people with six figure incomes and seven figure home prices. And of course, whether that is right or not is beside the point, but you need to understand the reality if you’re going to test the water.
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.)
My clients get tired of hearing me say it, but if the mantra for real estate values is location, location, location, then the mantra for bankruptcy petition and schedule preparation is disclose, disclose, disclose. This isn’t Chicken Little screaming about the sky falling; it’s real and it can have real consequences.
The 8th Circuit Court of Appeals recently decided the case of In re Barrows. In that case, the debtors borrowed money from their 401(k) just before their bankruptcy petition was filed, and deposited the funds into their bank account. They didn’t tell their lawyer about it. On their bankruptcy schedules, they disclosed–under penalty of perjury–that their combined bank balance was $325 on the day of filing. The trustee requested bank statements, and those statements revealed the additional funds. When their lawyer sought to amend the exemption schedules to include the additional funds apparently mistakenly omitted, the Court denied the amendment and the debtor’s appealed. They lost the case and, therefore, their $13,000.
The Court of Appeal reasoned that, because the debtors signed their schedule under penalty of perjury, such omissions can’t be cured by simple amendments. The Court upheld the lower court decision, and the debtor’s lost the $13,000.
The most painful–and truly absurd–irony of this tale, however, is that, because the money was borrowed from the debtor’s 401(k) retirement account, and would have been exempt if either a) They had waited until after filing to borrow the money, or b) Correctly disclosed the bank balance and source of the funds. The important issue for the Court of Appeal wasn’t whether the funds would have been reachable by the creditors or the trustee, but the debtor’s “bad faith” in failing to be truthful in the schedules. In other words, the doctrine of “no harm, no foul” doesn’t apply. This kind of stuff drives me nuts because it is so easily avoidable.
I take three lessons from this:
1. Don’t expect post petition amendments to cure material omissions without the threat of some possible consequence.
2. Truth matters. A lot. Innocence alone doesn’t vitiate inaccuracy.
3. If you are untruthful in your schedules, you should expect to be caught.
Here in the Northern District of California, Judge Alan Jaroslovsky of the Santa Rosa Division wrote an Open Letter to Debtors and their Counsel in 1997 with regard to the casual assumption that inaccuracies can be easily cured with later amendments. You can read the original order here.
But to quote the most important message from the 1997 Open Letter, Judge Jaroslovsky says:
Whatever your attitude is toward the schedules, you should know that as far as I am concerned they are the sacred text of any bankruptcy filing. There is no excuse for them not being 100% accurate and complete. Disclosure must be made to a fault. The filing of false schedules is a federal felony, and I do not hesitate to recommend prosecution of anyone who knowingly files a false schedule.
That’s worse than losing $13k.