Nolo’s Bankruptcy Blog

An article titled “Lose Homes, Pay More Tax” by Jonathan Glater, published in the May 30, 2008 edition of the New York Times, accurately described a little-known oddity of our tax laws (described in the article as a “tax bomb”). If a lender forgives or writes off debt (same thing), the amount forgiven can be treated as taxable income by the IRS. So, for instance, if you have a second home (not your primary residence) and you lose it to foreclosure or even a short sale, you will be taxed on the shortfall to the lender. Fortunately, loans made to acquire or improve primary residences are excluded from this rule for tax years 2007 through 2009.

What the Times article left out — strangely, seeing as so many bankruptcy lawyers were quoted — is that there are two exceptions to the tax bomb. If you are insolvent at the time of the debt forgiveness, you will also be forgiven your tax liability. And, here’s the kicker: If you file bankruptcy prior to the debt forgiveness (read: foreclosure) the bankruptcy will not only hold off the foreclosure (at least temporarily), but also discharge the debt, so there’s nothing to forgive and no income to tax.

Insolvency can be difficult to prove after the fact, but there is no doubt about the bankruptcy exception. Although many people shy away from bankruptcy, it can be a marvelous remedy when dealing with the possibility of foreclosure. It’s beyond my comprehension why that point wasn’t made.

An article on Newsweek’s website asserts that chapter 7 bankruptcy filings are following an upward trend, with more and more people seeking bankruptcy protection, despite recent changes to the law making it more difficult to file. Readers of this blog will know that I advocate bankruptcy as a way to avoid foreclosure; according to Newsweek, filing bankruptcy to deal with an imminent foreclosure is one of the reasons for the boom:

In some cases struggling homeowners are filing to prevent foreclosure. (A record high 243,353 homes went into foreclosure in April, according to data released on May 14 by RealtyTrac.) Squeezed by rising costs for everyday necessities like gas and groceries and unable to tap into their homes for temporary relief — declining values have left some people owing more than their homes are worth; it’s also more difficult to get home equity lines of credit or loans — many people have turned to their credit cards “as a last resort,” says Robert Lawless, a professor of law at the University of Illinois who follows bankruptcy trends.

While digging the debt hole deeper seems like it might be a good idea in the short term, filing bankruptcy now will help you avoid the costly penalties that credit card companies will saddle you with as your balance goes ever-upward. If you’re thinking of filing for chapter 7 bankruptcy, be sure to visit LegalConsumer.com, my co-blogger’s website, to try out his free means test calculator. The calculator can quickly tell you whether you qualify for chapter 7 bankruptcy under the changes in the law that went into effect in early 2008.

As the credit crisis continues and foreclosures continue to rise, Nolo has gathered the most relevant and helpful articles and tools for anyone facing foreclosure. There, you can find articles by me and my colleagues on everything from reducing the number and amount of mortgages on your home, to tips on how to spot the shady characters who will try and take advantage of you at a most vulnerable moment — when you’re struggling to hang on to your home. And, of course, there are answers to those nagging questions that need to be answered immediately — like how long you can stay in your home once foreclosure notice has been given.

To find out what the law has to say about these issues and more, check out the brand new Foreclosure area on Nolo.com. Soon we’ll be adding an article on foreclosure basics and an FAQ with answers to common foreclosure questions.

The subprime mortgage and credit crisis shows no sign of waning anytime soon, and if you’re one of the millions being foreclosed on, panic may be quickly setting in. But just because a solution seems unreachable doesn’t mean that you can’t plan ahead to minimize the possibility of foreclosure or mitigate the damage if you find yourself sliding toward it.

Lately, I’ve been working with my colleagues at Nolo to produce useful materials that will help anyone in any stage of the foreclosure process — from those struggling with their new jumbo loan repayments to those with an eviction notice already pasted to their front door. Here are a few of the articles I’d recommend to interested readers:

• My latest article covers the process of reducing your mortgage obligations to help you avoid foreclosure and stay in your home.
• Similarly, Ilona Bray gives you a rundown of all the ways you might be able to stay in your home and keep foreclosure at bay, as well as what to do if you discover that foreclosure is inevitable.
• A cautionary article: Don’t Lose Your Home to Foreclosure “Rescue” Scammers. Many unscrupulous people are using the mortgage crisis to prey on those going through one of the most difficult times in their lives. This article gives you the tools to recognize those attempting to defraud you, and how to check up on the legitimate rescuers.
• What happens when your landlord’s rental property is being foreclosed upon? Janet Portman provides the information any renter in this situation will need, including warnings about angry, law-breaking landlords and solutions for tenants who find out their new landlord is the bank.

On January 23, I wrote in this blog that people ought to use their rebate check to file bankruptcy. I pointed out that past attempts to stimulate the economy in this manner had pretty much failed, due to the fact that people used the money to pay down their debt, and that this time the loan sharks would gobble up most of the government’s gifts hook, line, and sinker.

In an April 25, 2008 Associated Press article by Tom Raum, President Bush is reported to have said the money would help Americans cope with rising gasoline and food prices, as well as aid a slumping economy. According to the article, Sen Charles Schumer (D. N.Y) responded: “It’s galling to think that taxpayers’ stimulus checks will be lining the pockets of OPEC. The sad truth is that the average American family will spend almost their entire stimulus check on higher gas prices this year.”

Let’s say it like it is: George Bush (and, not so coincidentally, most of Congress) is giving their oil buddies a $150 billion tax rebate. It may be in your bank account for one brief moment, but it will quickly be recycled into the major oil companies’ coffers. All of this takes place in the context of the worst housing slump since the depression, record foreclosure numbers, and a recession in many — if not all — states.

My earlier proposal makes even more sense now. It will help folks who really need help and will serve to make our economy stronger. Everyone with significant debt (which is just about everyone) should use his or her rebate check to file for bankruptcy. The entire process can cost as little as $600 for people who represent themselves (which many currently do, with paperwork help from paralegals and targeted legal advice from lawyers). And even if you choose to hire a lawyer to represent you, the proposed rebates will definitely give you a good start on the fees, especially if you are married.

Read the rest of this entry »

Pretty much every bankruptcy attorney will tell you the same story: When you ask a client why he or she wants to file bankruptcy, the typical answer is, “I can’t stand the phone calls.” I get story after story from normally gregarious people about how they and their families are living in fear of their telephone.

Most people who fall behind on their debts feel guilty, and the debt collectors know it. They prey on that guilt in the expectation that money will somehow be found — the children will withdraw from college, the daughter will forgo her braces, the mother will take a second job (leaving an empty house for the children to come home to). In the proud tradition of community loan sharks, it makes no difference to the collectors where the money comes from, only that it be paid.

My reaction when I hear these stories? My outer self clucks in sympathy while my inner self gets really furious at the fact that these good people have been made to feel like criminals by the real criminals: The credit card companies that charge 30% interest, trap people into over-payments and delinquencies by unfair billing practices, and raise interest rates on the basis of late payments on unrelated debts.

I also get frustrated because, of the hundreds of people I’ve counseled in the past several years, not one person knew that they could use a federal law known as the Fair Debt Collection Practices Act to stop collection agencies from phoning them — and from engaging in a lot of other harassing conduct. Whether or not they decide to file for bankruptcy, these people come away from my counseling greatly empowered by a bit of information that every citizen should know at least as well as they know the pledge of allegiance.

And (drum roll, please) the information is, you can make a bill collector bug off with the following letter, properly addressed to the harassing debt collector:

Attn: [Collector],

Re: [Your name], [Account #]

Dear [Collector]: For the past three months I have received several phone calls and letters from you concerning an overdue [Creditor’s name] account. This is my formal notice to you, under Title 15 United States Code Section 1692c, to cease all further communications with me except for the reasons specifically set forth in the federal law. This letter is not meant in any way to be an acknowledgment that I owe this money.

Very truly yours,

[Your name]

The Fair Debt Collection Practices Act has some enforcement teeth, including stiff fines payable to the victim, and attorneys’ fees. Unfortunately, it’s sometimes hard to put together a case. The best approach is to start recording your calls, which is okay as long as you tell them you are doing it. This alone may chase them off, but if they are so brazen as to continue calling you after you have told them not to, and they talk for the benefit of the recorder, you may have a good case to take to a lawyer for follow-up.

Unfortunately, the federal Fair Debt Collection Practices Act doesn’t apply to the original creditor, and when creditors own their own collection agencies, as some of the big ones do, the line is gray regarding the federal law’s applicability. Also, there are some collectors that aggressively push the envelope in their collection activities and frequently violate your rights under the Act. Nevertheless, many states have similar laws that do apply to the original creditor and the almost universal effect of a letter such as the one I’ve described above is to stop the harassment, regardless of whether it is the creditor or a collector who is making the calls.

If you’re like many homeowners, your home is encumbered with a second or third mortgage (or deed of trust), and perhaps a home equity loan. Numerous articles describe you as using your home like an ATM machine. Having all these secured debts on your home is tantamount to a juggler having too many balls in the air — at least one must fall, sooner rather than later.

If, for one reason or another, you just can’t keep up, you may be able to avoid foreclosure if you pay the right loan and either blow off the rest, or at least make reduced payments. In almost every case, the right loan to stay current on will be your first mortgage or deed of trust. While I’m always hesitant to tell people to stop meeting their shelter obligations in full and on time, sometimes it’s the only rational thing to do — as wrong as it may feel to many of you. If reducing the amount you throw at your home every month will let you stay there and keep your ahead above water, at least until you can work out a better solution, I’m all for it.

How does this work? When you originally took out the loan to buy your home, you agreed to have the loan (or loans) secured by a mortgage or deed of trust (depending on the state where the property is located). (For the rest of this blog, I will use the term “mortgage” to refer to both mortgages and deeds of trust.) By recording the mortgage in your local land records office, the lender created a lien (legal claim) on the property, which can be enforced by foreclosure if the payment terms of the mortgage document aren’t met. As you probably know, in foreclosure the property is sold to make good on the promissory note underlying the mortgage.

The main loan you used to buy your home is termed a “first mortgage.” Why first? It’s almost always recorded first and gets paid first in case of a sale. In the same manner, a second loan secured by the home is a second mortgage. For example, it’s common to use a first mortgage to pay 80% of the sale price and get a second mortgage for the additional 20%. And that’s not all. In the bubble years, home value appreciation supported additional loans against the home, often in the form of a home equity lines of credit. As with the first mortgage, the lender’s primary remedy for a default on these additional loans is foreclosure. Read the rest of this entry »

If you have old, unpaid debts, you may be safe from a lawsuit to collect the debt, because a creditor or debt collector has a limited number of years to sue you for the debt. To get a better understanding of time limits for debt collection, check out this newly published article in the Nolopedia, “Time-Barred Debts: When Collectors Cannot Sue You For Unpaid Debts”.

And if you want further information on debt collection & credit, you might also be interested in my previous post, “When Credit Bureaus Report Debts Discharged in Bankruptcy: It Should Be a Crime”.

Just about everyone in and out of government is talking about putting cash in the hands of consumers to stimulate the economy. The only real points of disagreement seem to be which consumers and how much. The President wants to rebate taxes to the people who make enough money to pay taxes—the middle- and upper-classes, by definition. Democrats want people who are too poor to pay taxes to also get a piece of the action. The idea, of course, is that the recipients of this largess will kick-start the economy by immediately spending the money on consumer goods and services—appliances, cars, clothing, vacations.

The last time the government sent checks to people to help out the economy was in 2001, and many recipients used the money to pay down their debt and keep the collection agency wolves from their doors. This time around, the national consumer debt has more than doubled—and it is even more likely that the loan sharks will gobble up most of the government’s gifts hook, line, and sinker. Maybe increasing the government debt by $100 billion in order to fatten the credit card and consumer finance companies will put some more credit in consumers’ hands—just what we don’t need—but if we follow President Bush’s lead, the folks who own the finance industries will be the ones who ultimately benefit.

Here is a modest proposal that will help folks who really need help as well as make our economy stronger: Everyone with significant credit card debt (which is just about everyone) should use his or her check to file for bankruptcy. The entire process can cost as little as $600 for people who represent themselves (which many currently do, with paperwork help from paralegals and targeted legal advice from lawyers). And even if you choose to hire a lawyer to represent you, the proposed rebates will definitely get you started.

Bankruptcy has been around since biblical times, and has long been recognized as an important component of the capitalist economy in that it restores debtors to the consumer marketplace. Specifically, bankruptcy gets rid of credit card and most other kinds of debt (exceptions are alimony and child support; most student loans; recent taxes; and debts caused by fraudulent or willful and malicious actions). Most people are solvent for the first time in years when they emerge from bankruptcy, and once again are able purchase goods and services without going into more debt. Just imagine how the economy would hum if consumers were freed from the punishing interest rates that often creep over 30% for technical violations of credit contracts.

By filing bankruptcy, people will use their government checks to improve their own balance sheet, instead of donating their money to the fat cats who use the large credit corporations to bleed us dry. While it’s true that mass bankruptcy filings would tighten rather than loosen consumer credit, it’s not a bad idea for us to break our national addiction to debt and learn to pay as we go.

Proposals for dealing with the foreclosure crisis frequently include allowing bankruptcy judges in Chapter 13 cases to modify residential mortgages to bring them in line with the actual value of the debtors’ homes, and, where appropriate, reduce the interest rate. This would often result in substantially reduced mortgage payments. At present, only non-residential mortgages can be modified in Chapter 13 bankruptcy.

While this approach to mortgage-debt relief seems helpful on the surface, it has one important flaw. A large number of people facing foreclosure are unable to propose feasible Chapter 13 plans that would be a prerequisite for the proposed relief. Proposals for mortgage debt relief in bankruptcy should include Chapter 7 bankruptcy as well as Chapter 13 bankruptcy.

It of course makes sense to use Chapter 13 as the vehicle for residential mortgage modifications — Chapter 13 already allows for modification of other types of secured debts, and provides for amortization of mortgage arrears over the life of the plan. However, to extend the relief to the many debtors who can’t use Chapter 13, Chapter 7 bankruptcy judges should also be authorized to modify mortgages and interest rates, and fold any arrearages into the newly modified mortgages. This will permit debtors to emerge from Chapter 7 with their home ownership intact, and reap the benefits of lower mortgage payments as part of their fresh start.

Not every person or family would be eligible for this relief. The bankruptcy judge would determine whether the debtor could afford the modified mortgage after bankruptcy. This determination would be based on the debtor’s income, income history, and other expenses. If the judge decides that the mortgage would cause the debtor undue hardship or interfere with the debtor’s fresh start, the mortgage would remain as is, and the creditor would be given a green light to proceed with the foreclosure. Importantly, this is the same procedure as is already used in in Chapter 7 “discharge hearings” when self-represented debtors seek to reaffirm car notes and other secured debts.

Perhaps using Chapter 7 as well as Chapter 13 bankruptcy for mortgage modifications doesn’t go far enough. Maybe a special federal court procedure should be set up where anyone facing foreclosure can apply for relief without having to file any type of bankruptcy. There may be constitutional impediments to modifying mortgages outside of bankruptcy, but, if not, it would be wonderful to have a universal procedure for residential mortgage relief, at least from the standpoint of the millions of borrowers subject to predatory loans and flat-out unaffordable mortgages.