More and more homeowners are having difficulties meeting their mortgage obligations. The reasons for such struggles are many and varied, as are the options available to address them. There is no “playbook” for a struggling homeowner to follow when in such a position. Serious issues have to be confronted and considered. A good starting point for every homeowner is to recognize that “thou shalt save your house at all costs and in all circumstances” was not the Eleventh Commandment delivered by Moses from Mount Sinai. Cash-strapped homeowners are not required to save their house. They can try to if they want to, but hopefully will only try to do so when it (1) makes economic sense, and (2) is consistent with the long-term goals of the homeowner. This inevitably leads to the threshold question that everyone must ultimately address and come to terms with “What do we REALLY want to do?”
In a Chapter 13 Bankruptcy, you can repay your past-due mortgage payments over a period of up to five (5) years using your future, regular income. To have a viable Chapter 13 Plan a debtor must have disposable income left over in their monthly budget after all cost of living expenses have been paid, including the defaulted mortgage, property taxes and homeowner’s insurance.
If a debtor has a second mortgage that is totally underwater (i.e. the house is worth less than is owed on the first mortgage), the second mortgage can be “stripped off” in Chapter 13 Bankruptcy, which means it is eliminated and no longer has to be paid. A debtor in a Chapter 13 Bankruptcy can also attempt to modify a defaulted mortgage by employing the Southern District of New York’s Loss Mitigation Program, which is Bankruptcy Judge-supervised mortgage modification.
In addition to catching up on past due mortgage arrearages, an added benefit of a Chapter 13 Bankruptcy is that a debtor’s unsecured debt usually can be discharged by payment of only a fraction of the amount owed, paid over (up to) five (5) years.
For those whose debts exceed the Chapter 13 debt limitations, a Chapter 11 bankruptcy can be used (much like Chapter 13) to catch up on past-due mortgage arrearages and strip off “underwater” second mortgages. Chapter 11 debtors can also avail themselves of the Court’s Loss Mitigation Program and attempt to obtain a mortgage modification. Chapter 11 cases are much more expensive and complex than those under Chapter 13.
Chapter 7 bankruptcy does not provide a specific platform to allow homeowners to catch up on past-due mortgage arrearages. However, every bankruptcy lawyer frequently hears from his clients “I could get caught up on the mortgage if I didn’t have so much credit card debt”. If this sounds familiar, a Chapter 7 Bankruptcy may be the answer. With the credit card debt discharged in bankruptcy, all of a client’s income can be focused on making their regular mortgage payments and catching up on the arrearages. This strategy can be employed only if the lender has not already “accelerated” the mortgage, which means declaring that the entire unpaid balance is immediately due and owing. The most common way a lender accelerates a mortgage is by serving you with a foreclosure summons and complaint.
A debtor in a Chapter 7 Bankruptcy can also attempt to modify a defaulted mortgage by employing the Southern District of New York’s Loss Mitigation Program, which is Bankruptcy Judge-supervised mortgage modification.
For a homeowner who has no realistic chance or desire to “save the house”, a Chapter 7 Bankruptcy will eliminate the debtor’s personal liability to pay any mortgages or judgments that are liens on the house. The homeowner is generally free to live in the house until the “gavel” goes down at the foreclosure auction sale, which can provide many months of mortgage-free and rent-free living, during which time it should be possible (at least in theory) to accumulate sufficient funds to be able to afford a security deposit elsewhere.
It should be noted that any mortgage obligations discharged in bankruptcy under any Chapter (i.e., 7, 11 or 13) is not considered a taxable event and triggers no income tax consequences.
This is becoming a more frequent option for homeowners whose house is hopelessly “underwater” (i.e., worth less than the outstanding mortgage obligations), although it is an option that this law firm DOES NOT RECOMMEND. For someone who bought at the height of the local real estate boom (circa 2006) and put very little money down, it will be many, many years before the house has any equity. Someone employing this tactic can live in the house until the foreclosure auction sale occurs, and given the complicated foreclosure process in New York this is usually a year or more (18 months is a realistic generalization) after the first mortgage payment is missed. However, this strategy does not guarantee that you are out of the woods, for the following reasons:
1. A foreclosing lender in New York has a ninety (90) day period after delivery and acceptance of the Referee’s Deed to bring on a motion before the Court seeking a deficiency judgment. A deficiency judgment can be entered by the Court if the mortgage balance owed to the lender exceeds the greater of (1) the fair market value of the real estate, if no one bought it, or (2) the proceeds actually realized from the auction sale. If the lender does not make a deficiency judgment motion within said ninety (90) period, they are forever barred from doing so. If they do bring on such a motion they will undoubtedly obtain a judgment against you in a large sum, and at said time you might have to consider a Chapter 7 or Chapter 13 Bankruptcy filing to address this resulting judgment.
2. If no deficiency judgment is sought, most mortgage lenders are required to send a Form 1099-C Cancellation of Debt form to both the IRS and the homeowner. Since debt forgiveness / cancellation is viewed by the IRS and NYS Tax Dept. as income which must be reported on your next tax return, this can have unwelcomed income tax consequences for the homeowner. Filing a bankruptcy BEFORE the mortgage lender issues a Form 1099-C is the best way to insulate yourself from this potential exposure.
3. If there are multiple mortgages encumbering your real estate and the senior (oldest in priority) lienholder completes its foreclosure the junior lienholders (i.e., second mortgages, HELOCs, etc.) automatically lose their lien(s) on the real estate. However, a junior lienholder can, and probably will, sue you personally on the promissory note (that you signed simultaneously with the mortgage) in order to obtain a judgment against you and collect the balance due on their loan. Alternatively, the junior lienholder may (but probably will not) elect to forgive your debt, which can give rise to the same Cancellation of Debt income tax issues that are referenced in the above sub-paragraph 2. Regardless of which tactic the junior lienholder(s) employ, only a bankruptcy filing can extricate you from this type of jeopardy.
In this option, the mortgage holder accepts a deed to the house from the homeowner in exchange for releasing the homeowner from the mortgage payment obligation. The homeowner wants the deed in lieu of foreclosure (“Deed in Lieu”) to be in full satisfaction of the balance due on the mortgage. However, no New York law expressly prohibits a lender from seeking a deficiency judgment against the homeowner following a Deed in Lieu. To avoid this prospect, the agreement or estoppel affidavit between the homeowner and the lender should expressly state that the transaction is in full satisfaction of the mortgage debt. As extra protection, to avoid the possibility of walking into a potential “taxable income” headache created by the lender sending out a Form 1099-C Cancellation of Debt form, it can be negotiated so that there is a provision in the agreement with the lender expressly acknowledging that the amount of the debt is disputed, and for that reason there is no deficiency or forgiven debt.
Once you deliver the “Deed in Lieu” to the lender, you no longer own the house, and will have to obtain alternate living accommodations. The senior mortgage lender will only accept a “Deed in Lieu” if there are no other junior liens (i.e., 2nd mortgage, judgments, etc.) encumbering the property.
It should be noted if a Deed in Lieu is accomplished through the government’s Home Affordable Foreclosure Alternatives Program (“HAFA”) the transaction is deemed to be in full satisfaction of the debt, so there are no potential deficiency judgment or income tax consequences.
In this option, the mortgage holder agrees to allow a real estate sale to occur even though their mortgage will not be paid in full at the closing. At the outset, the bank usually gives the homeowner a minimum price that the house can be sold for, and the house is then listed. If an offer is received that meets, or comes close to meeting, the bank’s minimum price, said offer is then presented to the bank to obtain their final approval. The sale cannot occur without the mortgage holder’s approval. If there are multiple mortgage holders, all must approve the Short Sale or it will not go through. The inability to get junior mortgage holders on board has been the death knell for many attempted Short Sales. This procedure is very time-consuming and frequently frustrating, both for the homeowner and for the potential purchaser. Sometimes the bank will “forgive” the entire shortfall, but other times they will demand that the seller sign a promissory note at closing for the amount of the “shortfall”, or for some agreed upon lesser amount. No New York law expressly prohibits a lender from seeking a deficiency judgment against the homeowner following a Short Sale. To avoid this prospect, the agreement or estoppel affidavit between the homeowner and the lender should expressly state that the lender waives its right to seek the deficiency. If the bank “forgives” any or all of the shortfall, the homeowner could suffer unwelcomed income tax consequences. The mortgage lender will send a Form 1099-C Cancellation of Debt form to both the IRS and the homeowner, and unless the homeowner qualifies for an applicable exclusion, the forgiven debt will have to be reported as income on the homeowner’s next federal and state income tax returns. This scenario also can be dealt with during the Short Sale negotiations with the lender, where it can be agreed that the amount owed is in dispute and, because of this, there is no deficiency.
It should be noted if a Short Sale is accomplished through HAFA, the transaction is deemed to be in full satisfaction of the debt, so there are no potential deficiency judgment or income tax consequences.
The mortgage modification option tends to drive homeowners nuts, as they submit the requested documents to their lenders over and over again only to be told, repeatedly, that the documents were never received and have to be resubmitted. In addition, the homeowner seems to never speak to the same bank representative twice, and each new representative seems to have no records of any prior conversations or agreements. Nevertheless, some people do endure the process and obtain a modification. All too often, though, people receive a denial after being in the process for a year or more, and this can be ruinous for the homeowner. Consider the following hypothetical: The debtor is four (4) months behind, the monthly mortgage payment is $2,000.00 per month (note: total arrearages of $8,000.00) and the debtor’s disposable income each month, after paying the mortgage and all cost of living expenses, is $200.00. Had the debtor filed a Chapter 13 bankruptcy at this time a monthly payment of approx. $150.00 per month to the Chapter 13 Trustee for 60 months would have cured the arrearages and the mortgage would have been back on track. However, if the homeowner instead elects to seek a modification at the outset, he is really rolling the dice. If he gets the modification, great, but if his application is denied after a twelve (12) month process (not an unusual scenario), the homeowner is now sixteen (16) months behind (instead of 4) with arrearages of $32,000.00 (instead of $8,000.00). The arrearages literally quadrupled during the application process and grew to an amount that can no longer be successfully addressed in Chapter 13 by debtor’s $200.00 per month disposable income. Be very careful about putting “all of your eggs” in the mortgage modification basket because you just might end up with a mess that you cannot fix.
There are some mortgage modifications, particularly those involving second mortgages, where the lender forgives some of the unpaid principal balance. When this occurs most mortgage lenders are required to send a Form 1099-C Cancellation of Debt form to both the IRS and the homeowner. Since debt forgiveness / cancellation is viewed by the IRS and NYS Tax Dept. as income which must be reported on your next tax return, this can have unwelcomed income tax consequences for the homeowner.
Due to the incredibly sloppy/fraudulent practices of many lenders during the “sub-prime feeding frenzy”, many homeowners have defenses to foreclosure actions now that were never available in the past, especially if the Mortgage Electronic Recording System (MERS) appears in the chain of title. Many lenders do not have in their possession the promissory note that forms the basis of the underlying obligation in the foreclosure, while other required certificates were/may have been impermissibly “robo-signed”, etc. Interposing these defenses into a foreclosure lawsuit can dramatically extend the length of a the foreclosure process. Your goals must be realistic if you adopt this strategy. You will not end up with a “free house” because ultimately you owe the money to someone. If you have a house that you will never be able to afford, and you just want to stay in the house for as long as possible before having to leave, this strategy can assist in that effort. However, if your long-term goal is to save the house and reach an accommodation with the mortgage holder, this strategy can, (in some instances), be counter-productive. Realistically, the best outcome that you could be looking at would be a mortgage modification at the Mandatory Foreclosure Settlement Conference. However, if you fail to receive a modification and the bank prevails in the foreclosure lawsuit, you probably will lose the house. For those who cannot afford the house that was the inevitable outcome anyway, but for others that was not necessarily the case. There are some homeowners who could have filed a Chapter 13 bankruptcy at the outset, when the arrearages were reasonable and could be cured by reasonable payments over a sixty (60) month Chapter 13 Plan, but instead they decided (for whatever reason) that they first wanted to “fight the bank”. If they “lose” the fight with the bank, by the time the battle is over the arrearages have grown so large that the homeowner no longer has the resources needed to succeed in a Chapter 13 Bankruptcy. Exercising bad judgment at the outset of the case can turn a potentially fixable situation (via a successful Chapter 13 Bankruptcy) into a disaster.
For more information about methods of addressing the problem of defaulted mortgages, you are encouraged to examine our more detailed treatments of:
The experienced foreclosure and bankruptcy lawyers at Hayward, Parker & O’Leary Esqs. will be more than happy to assist you in determining the best way to successfully address your Mortgage Issues.