When homeowners are confronted with impending foreclosure, they often will file for bankruptcy.
The act of filing for bankruptcy causes an “automatic stay,” which stops creditors from taking action, thus preventing a foreclosure, said Michael Sousa, assistant professor at Denver University’s Sturm College of Law.
Sousa said that if homeowners have unsuccessfully tried other means to ameliorate their debt, there are good reasons to file bankruptcy.
“Generally speaking, if you elect Chapter 13, it permits you to rehabilitate yourself and pay some of your debt back, and, theoretically, you won’t lose your home,” he said.
Chapter 13 bankruptcy requires, among other things, filing a plan with the bankruptcy court, including “a synopsis of how you will treat your creditors.”
Homeowners then have three to five years to repay their debts and then, say, six months of mortgage payments that are in arrears.
Without a bankruptcy, a homeowner whose $2,000 mortgage is six months in arrears would “have to come up with $12,000 to stop the foreclosure” — or lose the home.
“But with a bankruptcy, you’d have three to five years to pay off that arrears at $200 per month, plus your mortgage payment,” Sousa said.
Now, before you run — like a mountain goat down Class 4 terrain in search of a moss/lichen du jour — to the nearest bankruptcy attorney, at least hear what else he has to say.
“If you file Chapter 13 to save your home, the question then becomes: Do you have the ability to make the mortgage payments, pay the arrears, pay your ongoing bills (utility, insurance, etc.), and pay some of the bills to your creditors (as required by the court)?”
In other words, is your plan, according to bankruptcy court terminology, “feasible”?
Most people who choose bankruptcy do so for two reasons: To save their home and to get a chance to start over.
“But statistically, two-thirds (of all Chapter 13 plans) fail,” Sousa said.
Why? Because filers default on the mortgage again, or they can’t keep up with creditor obligations.
“Bankruptcy gives people a temporary fix — they get to significantly reduce their debt so they can move forward,” Sousa said. “Speaking from a 30,000-foot level, the notion of a fresh start is (fantastic). But if people haven’t made significant changes from their pre-bankruptcy state — increased their earnings or decreased their expenses — then they’ll end up back in the same situation.”
Now, for anyone tempted to be self-righteous out there, don’t be so hasty. The majority of failed bankruptcy plans are not — repeat, not — the result of people being spendthrifts/profligates/wanton fools.
“It’s not because they’re going out to expensive dinners, or taking vacations in Las Vegas,” he said.
In the short-term they’ll be OK, without increasing income or decreasing spending, Sousa said, but in the long-term, well, life and catastrophes happen.
“A divorce, or job loss, or death in the family, or the car breaks down, or a child gets sick or someone needs a medical test not covered by insurance — and they’ll be right back to where they were before,” Sousa said.
Unless, of course, they get more introspective than most people want to.
“After bankruptcy, you have to find a way to recalibrate your financial picture,” Sousa said. “And that comes from making tough choices. Do you need to pay $160 a month for cable and Internet? Do you need to pay $400 a month for a car, or would $150 or $200 work instead? You have to take a hard look at your financial picture and your prospects for making more in the future. Most people don’t want to do that — it’s scary for many people.”
But less frightening, it would seem, than falling back into overwhelming debt.
“The stigma of bankruptcy shows up for 10 years on a credit report,” he said. “In one sense — it’s horrible — but it’s not the end of the story. In the other sense, there’s the ability to resurrect yourself and your credit — but not without a price, huge interest rates and fees. Bankruptcy is a useful tool, but may not be the end victory in and of itself. You have to make significant changes going forward.”
Until the recession, people were living on credit and taking equity out of their homes to go on vacation, he said.
“A person has to take a realistic view of their life after bankruptcy and make sure to have cash reserves for emergencies and adequate insurance to reduce medical bills,” Sousa said.
And to make sure you never see the inside of a bankruptcy court, “pay off and then cut up those credit cards — they are evil,” he said. “Credit card companies make the most money on the consumers who are least able to pay. In the credit card industry, people who pay off their bills each month are called ‘deadbeats.’
“The best advice — bar none — is to attempt to live without using credit.”
Rebecca Tonn covers banking and finance for the Colorado Springs Business Journal.