Filing Bankruptcy Isn't Helping Homeowners Avoid Foreclosure

More borrowers are realizing that declaring bankruptcy can't save them from losing their residences.
By: Lingling Wei: The Wall Street Journal Online
More financially stretched borrowers are realizing even declaring bankruptcy can't save their homes from foreclosure.

Take, for example, Bernice and Harlan King in Cleveland. The couple, saddled with about $30,000 in credit-card and other debts and behind on their $1,650 monthly mortgage payments, filed Chapter 13 late last year to prevent their mortgage lender from repossessing their house. Their hope was to work out a plan to catch up with the mortgage payments and repay other bills over three to five years. Now they are giving up, and their house is heading for foreclosure.

"It's just too much trying to catch up," said Ms. King, 48 years old, a court stenographer.

The Kings and people like them present a worrisome trend for investors in mortgage-backed bonds already spooked by soaring delinquencies and defaults on home loans to people with the weakest credit. According to a study released in March by Credit Suisse Group, more subprime borrowers are turning to bankruptcy court to stave off foreclosure, as softening housing prices make it harder for them to sell their homes to repay debts.

At the same time, the study shows, the number of borrowers who are actually able to bring current their mortgage payments through bankruptcy is declining, and more filers are ultimately turning their homes over to the lenders. The finding means investors in high-yielding mortgage-backed securities should expect higher losses on the underlying collateral.

At least part of the blame, says the report, lies with a bankruptcy law passed in 2005. The law raised the bar for people to qualify for Chapter 7 "fresh start" bankruptcy proceedings. Chapter 7 can enable individual filers to wipe away debts such as credit-card and medical bills so they can continue to make their mortgage payments. With access limited, more subprime borrowers are forced into Chapter 13, where some can't maintain their payment schedules for more than a couple of months.

The Kings, for example, had thought about filing Chapter 7, but made too much money to pass the new bankruptcy law's means test, said Mr. King, an airline baggage handler.

"It's become harder to file for Chapter 7 to release debt burdens," said Jay Guo, a director in Credit Suisse's asset-backed securities research group in New York and the lead author of the study. "Going forward," he added, "delinquent loans are more likely to go into foreclosure directly rather than into bankruptcy," resulting in higher losses for mortgage-bond investors.

First American CoreLogic, a provider of real-estate information, expects to see 1.1 million foreclosures nationwide over the next six to seven years as a result of jumps in monthly payments on adjustable-rate mortgages made from 2004 through 2006.

Banks argue they try to help delinquent borrowers avoid foreclosures. The Mortgage Bankers Association estimates that three out of four borrowers who enter the foreclosure process find a way out that doesn't involve repossessing and selling the home. Alternatives include paying off the arrears through an agreed-upon payment plan or selling a home to avoid foreclosure and protect credit ratings. Often when these options fail, declaring bankruptcy is the last resort.

But many borrowers complain that lenders and loan servicers sometimes stop helping them after they file Chapter 13 for fear of appearing to be trying to collect, which is barred under the bankruptcy law. "It's a mischaracterization," said Larry Litton Jr., chief executive of Litton Loan Servicing, a unit of credit-sensitive asset purchaser C-BASS LLC.

Lenders and servicers have a financial incentive to help borrowers. Foreclosed properties may have to be resold at a loss -- especially in areas such as the Midwest's Rust Belt, where home prices are experiencing a more-dramatic slowdown than in the rest of the country. Companies may waive arrears, reduce interest rates or extend loan terms.

"We stand to lose a lot of money" when the company has to take back homes because borrowers can't pay their mortgages, Mr. Litton says. "We would absolutely be looking to restructure the debt in a way that is more conducive to keeping the borrower in the house."

Ms. King blamed her foreclosure mainly on the couple's lack of financial discipline. But she also blamed their lender's reluctance to help the family with a realistic repayment plan.

Spokesman Stephen Dupont at the lender, Homecomings Financial, part of GMAC Financial Services, declined to comment on specific customers. "We will always work directly with our customers to try to resolve issues when they arise," he said.