Reaffirming Home Mortgages

Recently I have gotten several calls from clients who have been told by some anonymous person at their mortgage company: "You should have reaffirmed your mortgage".

First off, what is reaffirmation?   It is a procedure under the Bankruptcy Code in which you sign a formal agreement stating that, even though you filed bankruptcy, you are still personally obligated to pay the debt.

How does this apply to mortgages?  Some background:  A mortgage is actually two things.  One is the promissory note, in which you promise to pay Wells Fargo Bank N.A. $100,000 at 4% interest over thirty years.  The second thing is the mortgage itself, which says that you put up a particular piece of real estate as collateral to secure the payment you promised to make in the promissory note.

A chapter 7 bankruptcy discharges the personal obligation to pay, but does not remove the lien from the real estate.  (Some mortgages can be removed through a chapter 13, but that is a different issue).

So, if you own a house and file bankruptcy and get a discharge, the end result is that you still must pay the mortgage to keep the home -- if you do not, the mortgage holder will foreclose its lien and take the home. However, if you have not reaffirmed, the mortgage holder cannot pursue you for any deficiency if the house does not bring enough to cover the amount owed on the mortgage.

If you have reaffirmed the debt, however, the mortgage holder could pursue you for any deficiency.  (This is not terribly likely, since most conventional mortgages in Minnesota are foreclosed by advertisement, with a six month redemption period -- but again, this is a subject to a different post.)


What are the benefits of reaffirming a mortgage debt?:

1)  If you do not reaffirm your mortgage in a chapter 7 bankruptcy, the lender may may not let you refinance with them in the future.  Wells Fargo Bank N.A., I am told informally, does this.  My response is:  Try a different bank.  There are dozens of them. 
2) The lender may (likely will) refuse to report your ongoing payments to the credit reporting agencies.  The work-around is to pull a payment history from the mortgage company and then pull a credit report (through (www.annualcreditreport.com) and  dispute the credit reporting agency report if your payments do not show up.

I hope the real estate market has stabilized, although I do not know for sure;  if so, it may be somewhat less scary to reaffirm a home mortgage.  However, you must realize that, if you reaffirm, you are putting yourself back on the line personally for a very large obligation, with no real benefit other than the two minor points noted above.  If the real estate market turns sour again, or the if the mortgage company chooses to foreclose by action, they can hold you liable for a very large deficiency, even though you filed bankruptcy.

1099C received from creditor?

Tax returns were just due, which means that I have gotten several calls from clients who have gotten a 1099C form from their creditor and want to know what to do.

A form 1099C is an IRS form (like a W-2) which a creditor uses to tell the IRS that a debt was forgiven, in whole or in part.

The IRS will get the form 1099C from the creditor and will think that you have taxable income.  This is because usually the cancellation of debt is a taxable event.  Say that you owe Discover Card $5,000, and you settle the debt by paying Discover Card $3,000.00.  On paper you are $2,000 better off ($5,000 owed minus $3,000 paid = $2,000 improvement), and that $2,000 looks like income.  As the basic rule is that income is taxable, it looks on paper as though you "made" $2,000.00.  

There are five exceptions to this however, of which two are most common.  You use IRS Form 982 to tell the IRS that one of the exceptions applies to you.

You can get Form 982 and the instructions at the IRS website, which is www.irs.gov  Also useful is Publication 4681, which goes into more detail and gives examples.   Both of these are free to download.

The first major exception to having to recognize cancelled debt as income is that the cancellation of the debt took place in a bankruptcy.  In my practice that is the most common.  Unfortunately, some creditors will send the 1099C even though the debt was discharged in a bankruptcy.   If your tax preparer does not ask you if you filed bankruptcy, you may wind up paying tax on cancellation of indebtedness income, even though the bankruptcy exception applies.  The moral of this part of the story:  Tell your preparer about your bankruptcy discharge and be sure a Form 982 is included in your filing, if applicable.

The second major exception, applicable outside of bankruptcy, is that after the cancellation of the debt you were still insolvent (meaning, you owed more than your assets were worth).  For example, let's say that you own nothing in the world except household goods and clothing worth $4,000 and a car worth $3,000 and $3,500 cash in the bank.  At the same time you owe Visa $4,000, MasterCard $3,000.00 and Discover Card $5,000.  So, your assets add up to $10,500;  your liabilities add up to $12,000.00.  You are insolvent by $1,500.  So, if you settle your Discover Card for $3,000.00, your situation now looks like this:

household goods and clothing $4,000
car $3,000
cash $500
total of assets: $7,500.00

Debts:

Visa $4,000
MasterCard $3,000
Discover Card $0
total of debts:  $7,000.00

So, before Discover Card cancelled $2,000 worth of debt,  you were insolvent by $1,500;  the cancellation of debt in the amount of $2,000 thus made your assets in surplus by $500.  Thus, in this example, you would have to claim $500 of income on your tax return from the $2,000 that Discover Card cancelled.

As you can see, the second major exception will involve some amount of math.

The point of this post, however, is to tell you  to not simply accept the 1099C as income;  get Form 982 and the instructions from the IRS website, fill it out, and file it with your taxes.  It may save you a lot of aggravation later on!

I  should add that there are three other exceptions, and that there is a very important one relating to "qualified principal residence indebtedness", meaning the mortgage against your home.  

For more details, get Publication 4681, which has a number of examples.

 CIRCULAR 230 NOTICE: In accordance with IRS Treasury Regulations, we are required to notify you that any tax advice given herein (including attachments) is not intended or written to be used, and cannot be used, by any taxpayer for the purpose of (1) avoiding any penalties that may be imposed by any governmental taxing authority or agency or (2) promoting, marketing or recommending to another person any tax related matter.

Seven years between filings?

I often hear that a person can file bankruptcy once every seven years. But that is not true.

As far as Chapter 7 cases go, and as far as I know, that has never been the right number of years; the time between chapter 7 filings in which you can get a discharge was six years before 2005; since 2005 it has been eight years.

Perhaps the folk wisdom of “seven years” ties back to the name of the type of case—a Chapter 7 case.

More likely it is because many types of adverse information drop off a credit report after seven years.

In any event, a person can file a "second" chapter 7 bankruptcy and get a discharge (which, after all, is the point of filing at all) only if it has been at least eight years between the date the first chapter 7 case was filed and the date the second chapter 7 case is filed.

The statutory cite is: 11 USC Sec. 727, which says, in part:

(a) The court shall grant the debtor a discharge, unless—

(8) the debtor has been granted a discharge under this section, under section 1141 of this title, or under section 14, 371, or 476 of the Bankruptcy Act, in a case commenced within 8 years before the date of the filing of the petition;

Notice that the time period is: filing date to filing date, not discharge date to filing date.

There are different time periods between the filings of a chapter 7 and a chapter 13; I will deal with those in a later post.

Homestead protection

     In Minnesota, we use the term "homestead" to mean two different things.  We use the term "homestead" to mean "Gets a break on real estate taxes";  but we also use the term "homestead" to mean "land that cannot be taken by a judgment creditor".
     In the context of bankruptcy, we almost always use the term in the second sense --  land that is exempt from the claims of judgment creditors. The Minnesota homestead law is comparatively generous. The law (Minn. Stat. Chapter 510) lets a person claim, as his or her homestead, up to 160 acres in size and more than $330,000 in equity. However, one of the rules is that you, or your spouse, have to actually live on the property.
     However, there is a way to protect your homestead from judgments even though you no longer live there.
     For example, assume you need to move from your property because you live in Grey Eagle and have lost your job there but find a job in, say, Albert Lea. Further assume that you have $100,000 of equity in your home in Grey Eagle, but you may need to file bankruptcy because, while laid off, you lost your insurance and incurred a huge medical bill.  
     What you do is this:  You file a statement with the County Recorder stating that even though you have left the property, you still claim it as your homestead.  The filing of that statement will protect the homestead for up to five years.
     A couple of cautions:  First, remember the statement above about the word "homestead" being used in two ways?  The form you file to claim "homestead benefit for real estate tax treatment" is filed with the County Assessor, not the County Recorder.  The form you file to claim "homestead as exempt from the claims of judgment creditors" is filed with the County Recorder.  Since it is easy to confuse the two terms, you must be certain that the right form is filed with the County Recorder, not just assume that because one form is filed with the County Assessor for real estate tax treatment that it carries over to judgment protection. Second, the form must be filed within six months of moving from the property.
     Because the Minnesota homestead exemption is so important, be certain to keep its protection in force even though you move.

Foreclosure problems

There are two ways to foreclose a mortgage in Minnesota, one is “by action” and one is “by advertisement”. 

The methods are set out in Minn. Stat. Chapters 580 and 581. 

A foreclosure “by action” means that the lender sues you, gets a judgment, and then has an auction of your collateral. A foreclosure “by advertisement” means that the lender sends you notices, publishes in a legal newspaper, and has a sheriff's sale, but there is no court involvement. “By advertisement” is somewhat cheaper and somewhat quicker, and it is the way virtually every Minnesota residential mortgage is foreclosed. 

The difference, from the borrower's standpoint, is that a foreclosure “by advertisement”, with a six month redemption period, means that the lender cannot come after you for a deficiency (a short-fall between the loan amount and the price at which the lender sells the home to another person). So, if your mortgage is $150,000, and the lender forecloses the loan “by advertisement” and with a six month period of redemption, even if the lender sells the home to a third party for $100,000.00, you will not owe the lender any money. (This assumes you don't do anything stupid, like destroy the house!)

If it is a conventional mortgage, the usual thing that happens is that Wells Fargo forecloses “by advertisement”.

However, if it is a VA mortgage , the Veterans Administration may well pursue you for any deficiency. The same thing applies to a Rural Housing loan through the US Department of Agriculture (formerly Farm Home Administration). It appears that an FHA loan has the authority to pursue you, but I have not seen that happen in practice.

So, you need to be certain what kind of mortgage you have.

Bankruptcy Reform 7 years later.

Bankruptcy Reform 7 years later.

     A friend reminded me that October 17 was the anniversary of the effective date of the "Bankruptcy Reform" act.  Then-President George W. Bush signed the law earlier, but most parts of the law became effective October 17, 2005.
     Some things have changed greatly, some things have not.
     Frankly, the changes have been less horrible than many of us (including me) feared.
     Bankruptcy has become more complicated, and therefore more expensive.  For instance, I now have to gather up paystub information for the prior six-plus months, and complete a form called a means test.  Very fortunately, if the result is "under median", we only have to complete two or three of the multi-page form.
     Another change has been the requirement to get pre-bankruptcy credit counseling from an approved counseling agency.  Because that was relatively unusual back in 2005, we thought that would be a substantial impediment to clients being able to file.  However, a whole new industry seems to have grown up to provide credit counseling on-line or by telephone.  There are probably at least forty such counseling companies who are approved in Minnesota.
     What has not changed is that clients are still in a lot of pain when they come in;  what has not changed is that people tend to throw in all their financial reserves in an effort to avoid having to file;  what has not changed is that people are very reluctant to file a bankruptcy.
     On that "happy" note, I will close this post;  however, I add that I am grateful that despite the best efforts of the credit card industry, which lobbied so hard for the 2005 law change, the bankruptcy law still generlaly works so that I can still help people shed their financial "millstone".

Jail for hiding "stuff"

The news today reports that ex-baseball star Lenny Dykstra pled guilty to several counts of bankruptcy fraud in federal criminal court.  The court's docket says: 
The Defendant Lenny Kyle Dykstra (1) pleads GUILTY to Count 1s,10s,12s. The plea is accepted. The Court ORDERS the preparation of a Presentence Report. Sentencing set for 9/3/2012 01:30 PM

Mr. Dykstra filed bankruptcy in California back in 2009, after playing professional baseball for the New York Mets.  There was a lot of activity in the case -- there are 528 entries on the docket -- and I have not slogged through them.  The news reports are that he hid $200,000 worth of baseball memorabilia and other items from his bankruptcy trustee.  Obviously the trustee found out about the hidden items and "turned him in" to the federal prosecutors.

Much like Denny Hecker here in Minnesota, this is an extreme case, likely prosecuted to send a message to other Americans who want to file bankruptcy.

Court cases abound with statements to the effect that "bankruptcy is for the poor but honest debtor".  Most of the time the items that bankruptcy filers try to hide are far, far less than the amount of the debt they would have gotten rid of had they played straight with the bankruptcy system.

After all, the bankruptcy trustee cannot keep the items for himself or herself;  the trustee has to liquidate the assets and turn them into cash.  The obvious target audience is the person who filed the bankruptcy case.  My experience is that bankruptcy trustees will gladly set up a payment plan for you to use to "buy back" your excess assets.  And, remember, the assets the trustee can take are those which are above the exemptions the law allows.  Minnesota law allows a person to keep a home with equity of more than $300,000;  federal bankruptcy law allows a person to keep a home with equity of $10,100.00 and another $11,975.00 of any property.  In both cases, this in addition to a modest car, retirement accounts worth up to $1,000,000.00, and about $10,000.00 worth of household goods.

The moral of this post:  Level with your attorney and with your trustee about what you own.  You can probably keep much more than you expect, and you can buy back the rest over time.  The cost of doing so is surely much, much less than the penalty of getting your bills back, even though you filed bankruptcy, not to mention the possible criminal penalties.