Mortgages & Sub-Prime Mortgage Meltdown

Written by Craig D. Robins, Esq.

President Barack Obama this week reiterated his support for bankruptcy reform during an appearance in Arizona, where he unveiled his $75 billion mortgage foreclosure prevention plan.

In several blog posts during the past two months I discussed how President Obama would likely reshape bankruptcy law during the early part of his administration (Will 2009 Bring Major Bankruptcy Law Changes? and Bankruptcy Change Under President-Elect Obama)

On February 18, 2009, he issued his bankruptcy proposal that would enable homeowners to change the terms of their mortgage in a Chapter 13 bankruptcy proceeding.

However, details of what President Obama would like in the Chapter 13 bankruptcy proposal are somewhat sketchy. He indicates that Chapter 13 cram-downs should be a final option; debtors must first ask their mortgage company for a loan modification and certify they have made reasonable efforts to cooperate with the lenders; and the cram-down would only apply to existing mortgages which have balances that are under Fannie Mae and Freddie Mac loan limits.

The bold plan removes restrictions that prevent Fannie Mae and Freddie Macfrom guaranteeing loans for mortgages valued at more than 80 percent of a home’s value. That rule prevents families from refinancing at historically low interest rates if they owed more than their homes are worth. Obama also says he will announce uniform rules for the mortgage industry to help homeowners restructure subprime loans. Lenders who want federal assistance will have to agree to the rules. Lenders will agree to lower interest rates and the feds will make up part of the gap between the old and new payments.   However, the finer points of the proposal need to be worked out.

This legislation would prove a godsend for thousands of homeowners on Long Island who face possible foreclosure.

Currently, bankruptcy judges on Long Island can effectively strip away a debtor’s second mortgage in cases where the value of the home is less than what is owed on the first mortgage. But judges remain powerless to alter the terms of a primary mortgage on one’s principal residence. Obama’s proposal seeks to change that.

Three weeks ago, the House Judiciary Committee reported to the full House H.R. 200, which would give Chapter 13 bankruptcy judges the authority sought by the president. A nearly identical bill — S. 61, sponsored by Senator Richard Durbin, D-Ill. — is pending in a Senate committee.

Written by Craig D. Robins, Esq.

The new bankruptcy laws that went into effect in October 2005 were officially dubbed “The Bankruptcy Abuse Prevention and Consumer Protection Act” by Congress. Up until recently, “abuse” was almost solely linked to the debtor, as in the situation where a debtor, who presumably had the ability to make some payments to creditors, instead sought to not pay creditors by filing for Chapter 7 relief. Now, the Court is also punishing creditors who it believes are abusing the system in different ways.

When the 2005 Act went into effect, the Office of the United States Trustee, a branch of the Department of Justice which is the federal regulatory agency that oversees the integrity of all bankruptcy proceedings, adopted an aggressive approach to enforcing the new law by seeking to strictly construe all aspects of the law as it applied to debtors. The U.S. Trustee focused most of its attention on investigating and pursuing debtors, but devoted very little time, if any, investigating any other party involved in bankruptcy proceedings.

Mortgagees are learning that they can by guilty of abuse also. For the longest time, there appeared to be widely disparate treatment of debtors who misrepresented facts, and creditors who brought frivolous proceedings or filed incorrect documents. In the past, if a mortgage company violated the rules — by bringing a frivolous motion to lift the stay or filing an incorrect proof of claim – then invariably the worst punishment it would get would be little more than a slap on the wrist. However, if the trustee discovered that a debtor grossly misrepresented his financial information, that would be considered a heinous malfeasance subjecting the debtor to litigation challenging dischargeability.

Let’s be clear here. Presenting any false information to the Court, whether intentionally or negligently, is a serious offense that should be punished. But the Court should treat all parties the same way – whether debtor or creditor.

The U.S. Trustee is stepping in to police abusive mortgagee practices. In the past half-year, with increased attention towards mortgage companies engaging in sloppy bankruptcy practices, the Office of the United States Trustee said enough is enough. In doing so, the U.S. Trustee has developed a new policy to police and punish those mortgage companies and their attorneys who flout their obligations to provide accurate information to the Court.

One particular lender, Countrywide Home Loans, has become the poster child for bad-boy bankruptcy practices committed by a mortgagee. In the past two months, several U.S. Trustees across the country have brought charges against Countrywide for abusing the bankruptcy process.

In cases in Georgia and Florida, the U.S. Trustee alleged that Countrywide made inaccurate allegations in motions to lift the stay, asserted liens that they were not entitled to, and collected money from a Chapter 13 trustee after the mortgage claim was satisfied. These actions were so newsworthy that The New York Times, the Wall Street Journal, and the Los Angeles Times prominently covered the story. The U.S. Trustee’s complaint alleged that Countrywide’s conduct and practices created unnecessary delay and expense, abused the bankruptcy process, and were sanctionable.

Although the U.S. Trustee has previously intervened in bankruptcy cases involving Countrywide in Florida, Ohio, Pennsylvania and Texas, this recent Georgia case was especially noteworthy because the U.S. Trustee initiated the suit on its own. In November, the U.S. Trustee subpoenaed Countrywide in at least a dozen cases regarding questionable claims for fees. Many of these cases are continuing.

Study shows mortgage proofs of claim contain significant errors. A recently published study revealed that mortgage companies are guilty of making tremendous mistakes with the proofs of claim they file. Katherine Porter, Associate Professor of Law at the University of Iowa, concluded that mortgage companies frequently do not comply with bankruptcy statutes regarding the filing of claims. She found that a majority of claims are missing one or more of the required pieces of documentation. She also found that fees are often poorly identified, making it impossible to verify if such charges are legally permissible or accurate. Hopefully the U.S. Trustee will also devote some attention to reviewing the accuracy of mortgagee’s proofs of claim.

Creditor’s firm severely sanctioned for sloppy mortgage bankruptcy practices. A very large and prominent Texas law firm that primarily is engaged in representing mortgagees in bankruptcy cases was severely sanctioned by the Bankruptcy Court for improperly calculating the legal fees. The firm, Barrett Burke Wilson Castle Daffin & Frappier, operates a high volume foreclosure and bankruptcy practice and frequently brings motions for relief from the stay. In each application, as is the usual practice everywhere, they asked for legal fees. In one case, In re Porcheddu, 338 B.R. 729 (Bankr.S.D.Tex. 2006), the judge felt the legal fees were not appropriate and demanded the mortgagee’s attorney to account for them.

The Judge discovered that in numerous instances, the mortgagee’s attorneys lied to the Court as to how the fees were calculated and also lied about keeping contemporaneous time sheets, when in fact they did not. After several hearings, the judge, incensed by this conduct, sanctioned the firm $125,000, although this amount was later reduced to $65,000.

Bankruptcy Reform involving creditors is needed. The 2005 Bankruptcy Act primarily reformed the law as it applied to consumers and made the entire bankruptcy procedure stricter for them. What we still need are laws that protect consumers from creditors and mortgagees who engage in poor and sloppy bankruptcy practices. Many mortgagees file incomplete claims with vaguely identified fees. Mortgagee’s attorneys often seek to lift the stay with information that is incorrect and unverified.

Professor Porter concluded that the existing system is insufficient to ensure the integrity of the bankruptcy system and its home-saving purpose. Systematic reform of mortgage servicing is needed to protect all homeowners – inside and outside of bankruptcy – from overreaching or illegal behavior. Hopefully the recent efforts of the U.S. Trustee will be the first step in this direction

About the Author.  Long Island Bankruptcy Attorney Craig D. Robins, Esq., is a regular columnist for the Suffolk Lawyer, the official publication of the Suffolk County Bar Association in New York. This article appeared in the April 2008 issue of the Suffolk Lawyer. Mr. Robins is a bankruptcy lawyer who has represented thousands of consumer and business clients during the past twenty years. He has offices in Medford, Commack, Woodbury and Valley Stream. (516) 496-0800. For information about filing bankruptcy on Long Island, please visit his Bankruptcy web site: http://www.BankruptcyCanHelp.com.

Written by Craig D. Robins, Esq.

The news has been replete with headlines these past few months about the crisis associated with sub-prime mortgages and the toppling of the sub-prime mortgage industry. American Home Loan, one of the nation’s largest mortgage lenders up until recently, and headquartered here in Melville, utterly collapsed.

The sub-prime mortgage problem has been attributed to the drastic increase in foreclosure filings that have skyrocketed this past year. Both the Nassau and Suffolk County Bar Associations have recognized the severity of the crisis by hosting symposiums in October. In this month’s column I will seek to present the problem in a nutshell and discuss ways consumer bankruptcy practitioners can assist their clients.

What Is a Sub-Prime Mortgage? A sub-prime mortgage is one that is generally made to a consumer with a poor credit history. These are typically individuals who have low FICO credit scores in the mid-five-hundred range or below, or individuals with blemishes on credit histories due to adverse life events, short employment history, or limited documentation. Since borrowers with sub-prime credit are greater risks, they do not qualify for conventional mortgages that have the most attractive rates.

The Sub-Prime Mortgage Market Exploded During the Past Decade. The sub-prime market has grown dramatically because of advances in credit scoring and underwriting technology, which enables lenders to charge different borrowers different prices on the basis of calculated creditworthiness. According to data reviewed in a recent Congressional subcommittee, in 1994, fewer than 5 percent of mortgage originations were sub-prime, but by 2006 about 20 percent of new mortgage loans were sub-prime.

Types of Sub-Prime Mortgages. Most of these mortgages are hybrids of Adjustable Rate Mortgages (A.R.M.). They tend to contain both fixed and adjustable rate components; they may have different payment options; or they may require payments of interest only for a period of time.

Exploding A.R.M.’s Are a Major Problem. A recent study showed that 72% of all sub-prime mortgages have “exploding” A.R.M. features in which interest rates jump incredibly, sometimes by as much as five percent, such as from a 7% annual interest rate to a 12% annual rate.

Factors Leading to Sub-Prime Mortgage Delinquencies. Rapidly increasing property values over the past decade helped to minimize problems associated with these mortgages. However, as a consequence of various economic factors such as rising interest rates, declining property values and a slowing housing market, consumers have faced great difficulty in being able to maintain mortgage payments.

Sub-Prime Mortgages Have Extremely High Levels of Default. According to the Center for Responsible Lending, one in five sub-prime mortgages originated during the past five years will end in foreclosure.

Most Sub-Prime Mortgage Problems Are Related to A.R.M.’s. Data has shown that the majority of sub-prime mortgage foreclosures relate to adjustable rate mortgages. These loans are often characterized by a rate that will adjust periodically–as frequently as every six months. Many homeowners become unable to make their monthly payments when their mortgage increases, usually unexpectedly, by many hundreds of dollars. When real estate was constantly increasing in value, borrowers with A.R.M.’s were often able to cope with payment increases by refinancing or selling.

Lenders Are Culpable for Loosening Sub-Prime Lending Standards. A recent study revealed that an unusually large number of sub-prime loans have gone into default shortly after origination. In many of these “early payment defaults,” borrowers stopped making payments, presumably knowing that they would be unable to meet their ongoing mortgage obligation.

This suggests that in 2006 some lenders may have lowered their underwriting standards to maintain volume as borrower demand slackened. It also appears that the rapid expansion of sub-prime lending in recent years, combined with rising real estate values, may have led lenders, investors, and ratings agencies to underestimate risks.

The major problem is that a great number of sub-prime lenders have given mortgages without adequate review to ascertain if the homeowner would have the ability to pay.

Abusive Practices Abound. The incredible increase in the number of defaults has focused attention on dubious /practices/ of many sub-prime lenders. It now appears that many mortgagees engaged in highly questionable /practices/tactics/ ranging from imprudent underwriting standards to abusive lending practices and even fraud.

Some of the abusive practices include high pressure tactics to sign mortgage documents that contain different terms than what was originally promised, and may contain higher interest fees and rate increases. Another significant problem concerns mortgage brokers making deceptive and misleading representations. For example, many homeowners entered into mortgages not even realizing that they were A.R.M.’s.

Another significant problem has been the large number of lenders who have given mortgages when it was obvious that the borrower would not be able to afford the payments. Some lenders have resorted to fraudulently using inflated appraisals that did not reflect true fair market value. Other lenders have been found to have “padded” the costs and fees at the closing by not disclosing them, or by requiring the borrower to purchase expensive credit life insurance.

Issues Facing Homeowners With Sub-Prime Mortgages. These consumers are often unable to pay; they face the risk of foreclosure; their credit may be ruined; they are often saddled with higher mortgage payments; they may be unable to re-finance; and they have difficulty selling their properties. Consequently, they may lose realized equity in their homes; they may see a decrease in the value of their home; they may suffer from negative credit records; and they may face the emotional trauma of foreclosure.

Helping Your Sub-Prime Mortgage Clients. Many lenders are becoming more receptive to repayment plans, forbearance agreements, loan modifications and short sales. However, some lenders will only review such applications by committee (a lengthy process), and only after the homeowner has supplied substantial financial documentation, only to advise the frustrated homeowner months later that the lender will not do anything to help.

No More Deeds in Lieu of Foreclosure. Several years ago, many lenders would accept a deed in lieu of foreclosure. However, as a result of tightening title insurance requirements and also because of provisions of the Home Equity Theft Protection Act, lenders will no longer consider this option.

Chapter 13 Bankruptcy Will Stop Foreclosure. Filing a Chapter 13 payment plan bankruptcy will certainly stop a foreclosure proceeding. However, the tricky part is that it will not stop the contractual rate of interest from increasing, which is what may have caused the homeowner to fall behind in the first place. Nevertheless, if the homeowner fell behind because of a temporary financial setback, but expects to be able to cover their mortgage payments in the future, then a Chapter 13 filing may be the perfect solution.

Be On the Lookout For New Legislation and Lender Policies. Proposed legislation has been recently introduced that would permit the bankruptcy court to modify mortgages. This is rather controversial and enactment is iffy at best. Meanwhile, some lenders such as Countrywide are anxious to persuade Congress that tighter mortgage regulations are not necessary by offering to work with troubled mortgagors. Thus, some lenders might consider refinances and modifications after all.

Watch Out for Scams. The homeowner in arrears is vulnerable and easy prey for con artists. One current scam is “phantom help,” in which a rescuer charges a fee to the homeowner and makes promises to rescue them, but just disappears. The “bailout” is a scheme to persuade the homeowner to sign over title to the premises, in which event the con artist sells the property and keeps the proceeds. Another scam is the “bait and switch” in which the con artist leads the homeowner to believe that the homeowner is signing a mortgage, but in actually is signing over title.

About the Author.  Long Island Bankruptcy Attorney Craig D. Robins, Esq., is a regular columnist for the Suffolk Lawyer, the official publication of the Suffolk County Bar Association in New York. This article appeared in the November 2007 issue of the Suffolk Lawyer. Mr. Robins is a bankruptcy lawyer who has represented thousands of consumer and business clients during the past twenty years. He has offices in Medford, Commack, Woodbury and Valley Stream. (516) 496-0800. For information about filing bankruptcy on Long Island, please visit his Bankruptcy web site: http://www.BankruptcyCanHelp.com.

Most Long Island homes have doubled in value over the past six years. This increase in real estate values has produced a windfall of increased equity to those who own homes, which in turn has affected the bankruptcy options of those homeowners who have serious debt problems.

Despite this boom, foreclosures are at record numbers. This may be attributable in large part to easy financing that enables people to refinance and obtain home equity loans without having to satisfy their existing credit card debts. Although most bankruptcies are attributable to financial crises such as large medical bills, divorce, loss of job, etc., many homeowners get into a bind because they tap their home equity ostensibly to satisfy existing consumer credit debt, yet continue to accumulate more debt.

The tremendous increase in real estate values also means that bankruptcy practitioners must be more careful in advising clients. In many instances, what was often done several years ago in the course of representing a consumer debtor homeowner should not be done today. Here are some tips and practice pointers that address how you should change your approach to such cases:

1. Be Cautious About Recommending Chapter 7 to Homeowners. Chapter 7 filings may not be feasible. Remember that the permitted homestead exemption in New York is only $10,000 worth of equity per person. In the early to mid 1990’s, many homes had declined in value and had very little equity. It was common practice during that time for homeowners to take advantage of utilizing Chapter 7 to eliminate their credit card debts, yet keep and protect their homes. However, the recent increase in real estate values means that there are extremely few homes that would be fully exempt and protected. What would have worked smoothly several years ago will not necessarily work well today.

2. Be Cautious About Submitting Chapter 13 Plans That Pay Less Than 100%. Before the real estate boom, when many homeowners had relatively little equity in their homes, it was commonplace to see many Chapter 13 plans offering only a 10% distribution to unsecured creditors, which is generally accepted as the smallest permitted distribution to that class of creditors. However, 10% plans in Chapter 13 cases for homeowners are becoming sparse as the amount of equity has substantially increased. If you offer a plan that pays less than 100%, the Chapter 13 trustee will very closely scrutinize that plan. If it appears that the amount of non-exempt equity is greater than the amount of unsecured debt, then you should consider a 100% plan.

Such 100% Chapter 13 plans offer many benefits over conventional refinancing. Generally, there is no interest on any mortgage arrears or unsecured debt. In most cases, only older mortgages which originated prior to October 1994 are entitled to interest. I explain to my Chapter 13 clients that a 100% plan is like a forced refinance that creditors must accept. It is as if the client borrowed all of the necessary funds to satisfy all existing debts, but was given the opportunity to pay that back with no interest over a five-year period.

3. Be Aware That Some Chapter 7 Trustees Are Becoming Very Aggressive. With the potential to administer a valuable asset (which in turn will pay the trustee a sizable commission), trustees are becoming very aggressive in trying to administer and sell houses as an asset of the bankruptcy estate. For this reason, even after you and your debtor client have engaged in due diligence before filing to ascertain the current fair market value of the property, it is quite possible to encounter a trustee who thinks the property is worth even more. The issues to consider in addressing such situations can easily take up an entire column and more, and I will try to devote a future column to this topic.

In any event, if you encounter a very aggressive trustee, some possibilities include: negotiating a settlement that can be paid from exempt, borrowed or gifted funds; converting to Chapter 13 (which overly-aggressive Chapter 7 trustees will try to oppose); litigating against the trustee; or letting the trustee try to sell the house, in which event the debtor would have to leave upon a sale, but this would nevertheless require the trustee to pay the debtor the $10,000 per person homestead exemption from the proceeds of sale.

4. Be Very Cautious About Real Estate Valuations. Several years ago, when real estate was not increasing at an incredible rate, many attorneys would simply tell their bankruptcy clients to obtain broker price opinion letters in order to determine the value of their property. However, in today’s very volatile real estate market in which values can change overnight, it is essential to utilize the services of an unbiased and highly qualified real estate appraiser. Be aware that in Nassau County, where there is a property value assessment system, the assessed value is not an accurate indication of the current value of the property.

Also be cautious that the appraisal can become obsolete within a matter of weeks or months. Many a client will retain a bankruptcy attorney, obtain an appraisal, and then put off filing for many months. If this happens, you should consider obtaining an update on the appraisal if the disposition of the existing case is very dependent on the real estate valuation.

Another difference in today’s practice is that trustees generally no longer rely on appraisals submitted by debtors or their counsel. Several years ago, trustees would often accept submitted appraisals as conclusive proof of the value of real estate. Today however, many trustees will obtain their own independent real estate valuation, often well before the meeting of creditors. Accordingly, the real estate appraisal is becoming more of a tool to assist counsel in determining how to best represent the client, than a means for persuading a trustee that there is little equity.

5. Consider Non-Bankruptcy Options Such as Refinancing or Sale. Bankruptcy is not the answer for everyone. Some debtors cannot file chapter 7 because of extensive non-exempt real estate equity, yet they are not eligible to file Chapter 13 because they do not have sufficient income to fund a plan. Keep in mind that there are a number of lenders who specialize in the sub-prime market. However, many individuals who are over-extended, or who have already cashed out most of their home’s equity, may not qualify for any type of financing. If bankruptcy and refinancing are both out of the question, then the only remaining option may be for the debtor to sell the home. It is important to help your clients be realistic about their options.

About the Author.  Long Island Bankruptcy Attorney Craig D. Robins, Esq., is a regular columnist for the Suffolk Lawyer, the official publication of the Suffolk County Bar Association in New York. This article appeared in the February 2005 issue of the Suffolk Lawyer. Mr. Robins is a bankruptcy lawyer who has represented thousands of consumer and business clients during the past twenty years. He has offices in Medford, Commack, Woodbury and Valley Stream. (516) 496-0800. For information about filing bankruptcy on Long Island, please visit his Bankruptcy web site: http://www.BankruptcyCanHelp.com.