Bankruptcy Indiana

Things are not going as smoothly as I would have liked in the Senate when it comes to the proposed new bankruptcy law. For the past year, I have been closely following the debate surrounding modification of mortgages through the bankruptcy courts.  The proposed new legislation, which was passed in the U.S. House of Representatives a little more than a month ago, has not been approved by the Senate.  There are many parts to this proposed new law, but three of them, I believe, could prove very important to my Indiana bankruptcy clients. 

A.  The new law would exclude mortgage debt on a principal residence when calculating debt for Chapter 13 bankruptcy.  That, in turn, would raise the debt limits that could be included in the bankruptcy.  (It is already possible under current law for a second mortgage or home equity loan to be dismissed in bankruptcy.)

B.  The new law would waive the pre-bankruptcy credit counseling requirement.

C..  (This was the crux of the debate in the Senate) The proposed new law would lift the ban on bankruptcy judges modifying mortgages.

Let's talk about why this third item is of so much significance.  If the law is passed, the changes would be retroactive to pending Chapter 13 cases.  That would help many of the hundreds of clients I've helped this year to prevent foreclosure on their homes.

Here's an example of how the process would work (IF the proposal were to be enacted into law:  
 
Ron and Sue bought their home for $400,000 a few years ago.  They have a first mortgage of $370,000 and a second mortgage of $15,000. The first mortgage was an adjustable rate mortgage or ARM.  The initial rate on the ARM was 5.2%, but it reset to 8%. The combined monthly payment went up by more than $1000.  Just then, Sue lost her job.  Since the couple's health insurance had been through that job, they were forced to buy COBRA; the premium for that is more than $1000 a month.  Ron's business is suffering because of the recession, so his income is down, and he also has health problems. Ron and Sue are behind eight payments on both mortgage payments, and they've received a foreclosure notice from their first mortgage lender.  They've tried negotiating with the lenders, but, because they don't have anywhere near the income they once had, and since the home itself has been appraised for only $315,000, they've been turned down for any compromise solution.

Under the law as is it today, Ron and Sue could file Chapter 13 bankruptcy and qualify for a five year debt repayment plan.  The second mortgage could be discharged in the bankruptcy, but they would need to make not only the regular first mortgage payments, but the "arrearage" on the eight months of missing first mortgage payments.  That's still far too much for them to handle on one income, especially since they'll have to pay the full cost for health insurance out of pocket.

Under the proposed new bankruptcy law, three things would be able to happen that could help Ron and Sue stay in their home:

   1. The bankruptcy judge could "cram down" the mortgage to the real current market value of $315,000.

   2. The amortization period of the mortgage could be extended to 40 years minus the age of the mortgage (five years in the case of Ron and Sue), meaning the payments would be stretched over 5 years.

   3.  The interest rate would be "fixed" (this would be done by adding a "risk factor" to prevailing interest rates.

(While there would be a trustee's fee to pay each month to cover the cost of the bankruptcy process, the total cost would be manageable given Ron and Sue's current income level.)

It's a complex issue, no doubt about it, and, as I've often repeated, I'm certainly no economist.  However, as a bankruptcy attorney in Indiana for almost twenty five years, I've seen the devastating "domino effect" the housing downturn has had on families' finances.  If at least some of the provisions of the proposed mortgage modification bill can be passed, the bankruptcy system would become a much broader safety net. Unfortunately, while all the Rons and Sues are struggling, debate is, at least for now, tabled in Congress.  And, at least according to BusinessWeek.com, "The odds of passing the legislation dwindle as time drags on."