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Bankruptcy and Foreclosure: How New Law Impacts Homeowners

The new bankruptcy law that took effect on Oct. 17, 2005, included many provisions that affect both residential and commercial real estate. But attorneys are still debating whether the real estate market overall will benefit from the changes. In this three-part series, we consulted with bankruptcy and real estate law attorneys on the specifics of how the new law impacts homeowners, renters, landlords and homeowner and condo associations. But whether the real estate market overall will benefit from the changes to bankruptcy law is debatable, in part because some kinks still need to be worked out, and also because fewer bankruptcies are being filed because consumers appear to be confused about whether they can still file for bankruptcy at all.

“There was this huge rush of bankruptcy filings before the new law took effect,” said Thomas S. Linde, an attorney, who specializes in real estate law and representing creditors in bankruptcy. “But the new law turned off the water, and filings trickled down to nothing in Washington state. People aren’t aware that bankruptcy is an option for them. They think the new law closed the door to them, and that’s not true. What Congress has done is imposed more requirements to get a bankruptcy discharge. It’s more onerous, but that doesn’t mean you can’t do it.”

Robert Nelson, a bankruptcy attorney, agreed that the new bankruptcy law has complicated personal bankruptcy filings. “The volume of filing in this jurisdiction has dropped by 80 percent,” he said.

One big yet unresolved issue for homeowners is whether the new law will result in more homeowners losing their homes to foreclosure. Under the new law, homeowners who are in arrears on their mortgage can’t wait until the last minute to file for bankruptcy — as many people do — to stop foreclosure (in legalese, it’s called “staying” the foreclosure).

“Before, bankruptcy was a last-minute thing,” Linde said. “If you were in foreclosure, you could file right before the foreclosure sale,” and in some cases stop the sale, he said. “Now, if you’re on the eve of foreclosure, it may be difficult to file if you wait until the last minute.”

That’s because a new provision requires that people filing for bankruptcy must undergo credit counseling before or within five days after filing their bankruptcy petition. To show you’ve complied with that requirement, you have to file a certificate with the bankruptcy petition stating that you’ve completed an approved credit-counseling course.

According to Linde: “The policy was to see if people could qualify for something short of bankruptcy, say, could they work a deal with creditors?” The counseling isn’t onerous, he says, and can often be completed in less than an hour online or by telephone, but it still must be arranged and completed, which can create delays for homeowners who need an immediate stay from a foreclosure action.

Linde said he’d recently seen “fewer people filing for bankruptcy to stop foreclosure,” but he’s not sure if it’s because the new law is more restrictive or because there’s uncertainty over some of the new provisions, and people and their attorneys are waiting for courts to clarify those muddy provisions. Over time, however, “I think fewer foreclosures will be stopped because homeowners won’t be able to file for bankruptcy as quickly as they could before,” he said.

Duane H. Gillman, an attorney, agreed. Homeowners who wait until the last minute to try to save their homes “may be unable to conduct the credit review in time, and that may have some impact on the number of homes lost to foreclosure,” he said. Gillman has served as a Chapter 7 bankruptcy trustee since 1982, which means he’s responsible for evaluating the assets and liabilities of people who file for Chapter 7 bankruptcy and liquidating the assets to pay creditors.

Real estate agents who specialize in foreclosed properties offer mixed reports on whether changes in the law have affected their inventory. “I got more foreclosed properties assigned to me in the first quarter of 2006 than were assigned to me in all of last year,” said Alex Macau, broker associate at Keller Williams Realty. “I can confidently say the new bankruptcy law has something to do with that.”

But Chris Mann, broker-associate at RE/MAX Horizons Group, who specializes in short sales and foreclosed properties, said the new law hasn’t affected his business in any noticeable way. “My business has gone gangbusters,” he said, “but I haven’t seen the bankruptcy law play a large part in that. The problems I see are because of interest-only mortgages and because two-year ARMs are coming due, and our economy hasn’t seen the growth it did in the past. These homeowners can’t refinance because they can’t afford the refinance fee, and they can’t afford the higher payments, so they’re short-selling or they’re losing their house to foreclosure.”

Bob Hodge of Circle Real Estate Services, who specializes in foreclosures, said he’s seen a huge increase in inventory—four times the amount three years ago. He’s sure the new bankruptcy law “has a little something to do with it,” but the more likely culprits, he said, “are the large number of 100-percent loans, interest-only loans, down payment assistance programs, and the slower economy.”

But Carl Bradley, founding broker of Eagle Realtors, who’s specialized in foreclosure sales for 29 years, questions whether filing for bankruptcy has ever helped homeowners in the first place. “Filing for bankruptcy didn’t affect whether people could save their house,” he said. “It was just a stall tactic. Even though homeowners can stop the foreclosure by filing for Chapter 7 bankruptcy, the mortgage company gets released from the stay and continues the foreclosure. Homeowners have to file for Chapter 13 bankruptcy to save their house, and if they do that, then their payment becomes higher than it was before. So I don’t think the new law is going to have a long-term affect on foreclosures for people who file for bankruptcy.”