«DiscoVeriNg HomelessNess Volume 13, Number 1 • 2011 U.S. Department of Housing and Urban Development | Office of Policy Development and Research ...»
Pence, 2006). Although some researchers are aware of the role bankruptcy protection plays in a borrower’s default and foreclosure decisions, they tended not to incorporate bankruptcy explicitly into their analysis (Ambrose, Buttimer, and Capone, 1997; Capozza and Thomson, 2006). The few exceptions are Bahchieva, Wachter, and Warren (2005) and Long (2005). Bahchieva, Wachter, and Warren (2005) documented the mortgage indebtedness of bankruptcy filers. Long (2005) examined the negative long-term effects of bankruptcy filings on households’ access to credit. Spurred by the financial crisis, more researchers are now beginning to examine more closely the relationship between foreclosure and bankruptcy. For example, White and Zhu (2010) built a theoretical Morgan, Iverson, and Botsch (2008) argued that the 2005 Bankruptcy Abuse Reform (BAR) has actually contributed to the surge in subprime foreclosures that followed its passage. Li, White, and Zhu (2010) found that the 2005 reform act caused mortgage default rates to rise.
For instance, the Helping Families Save Their Homes in Bankruptcy Act of 2009 proposed to amend the federal bankruptcy law to permit a bankruptcy plan to modify the mortgage of certain debtors and to provide for payment of such a loan at a fixed annual interest rate over a 30-year period. As of August 30, 2010, this bill was being considered in committee. The committee recommended it be considered by the House as a whole and placed it on the legislature’s calendar of business for floor consideration.
114 Refereed Papers The Homeownership Experience of Households in Bankruptcy model to explore households’ joint decision of bankruptcy and mortgage default. Levitin and Goodman (2008) studied interest rate variation by property type because the current Bankruptcy Code allows for mortgage stripdown only on non-single-family owner-occupied properties. Li and White (2009) examined the relationship among mortgage default, foreclosure, and bankruptcy.
Levitin (2009) tested the hypothesis that permitting modification would have a negative effect on mortgage credit cost or availability and argued that permitting modification of home mortgages in bankruptcy presents the best solution to the foreclosure crisis.
Similarly, despite ample analysis on mortgage foreclosure outcomes (Ambrose, Buttimer, and Capone, 1997; Gerardi, Shapiro, and Willen, 2007; Grover, Smith, and Todd, 2006; Lambrecht, Perraudin, and Satchell, 2003; Pennington-Cross, 2006; Stark, 1997), before this mortgage crisis, few studies tracked bankruptcy outcomes, especially the outcomes of chapter 13 bankruptcy filings. Of those that did, none followed up on homeownership experience during and after bankruptcy (Eraslan, Li, and Sarte, 2007; Norberg and Velkey, 2007).
This article attempts to remedy this gap in the literature. We built a unique data set that enabled us to track the homeownership experience of homeowners who filed for bankruptcy between August 2001 and August 2002 in New Castle County, Delaware, from the time of their filing to October
2007. We constructed three measures of homeownership experience by asking the following questions: How often do people lose their houses to foreclosure during and after bankruptcy? How much time elapses between a bankruptcy filing and the foreclosure sale? What is the recovery rate for lenders in the event that the house does end up in foreclosure? The article has three main findings. First, despite filing for bankruptcy, 28 percent of the filers lost their houses to foreclosure sale by October 2007. The foreclosure sale rates jumped to 41 percent for filers who were 12 months or more delinquent on their mortgage payments at the time of filing. To put these numbers in context, we followed houses that the New Castle County Sheriff’s Office listed as being in foreclosure sale but whose owners did not file for bankruptcy between August 1, 2001, and August 1, 2002.
We found that roughly 43 percent of these owners had their houses foreclosed by October 2007.
The comparison, therefore, suggests that bankruptcy does provide some relief to homeowners and more so to homeowners who missed only a few payments.
Second, compared with homeowners who went into foreclosure without filing for personal bankruptcy, bankrupt debtors remained in their houses for, on average, 28 additional months.3 This second finding confirms earlier findings in the literature: loans that move from delinquency into bankruptcy simply take longer to reach their ultimate resolution, which is foreclosure in the case of mortgage loans (Capozza and Thompson, 2006).4 Third, average final sale prices exceeded borrowers’ own estimates at the time of filing, resulting largely from the runup in house prices in the early period of our sample. Despite this, most lenders Because most filers for bankruptcy were already seriously delinquent on their mortgages, without bankruptcy filing, it is reasonable to assume that they would be in foreclosure very soon. Indeed, at the time of filing, about 27 percent of households in our sample were already in foreclosure.
Capozza and Thomson (2007), however, do not distinguish between chapters 7 and 13. By the nature of the system, chapter 13 filers may still be in bankruptcy 8 months after a 90-day delinquency. Thus, the relevance of their continued presence in bankruptcy over an 8-month period is difficult to interpret.
did not collect enough money to cover the total mortgage outstanding and the mortgage arrearage and, therefore, suffered severe losses. After adjusting for inflation and time cost of money using house price growth, we found that the lender lost an average of $14,165 per home and the median loss was $8,187. Assuming an additional 20-percent foreclosure fee (administrative fees, trustee commissions, and legal expenses), the loss increased to $33,516 for the average house price and $23,156 for the median price. Put in relative terms, lenders lost, on average, 28 percent of the amount that was owed to them, with one-half of them losing more than 31 percent.
To shed light on the current crisis, we identified important borrower, lender, and loan characteristics, as well as local economic factors that affect homeownership outcomes. We then conducted a counterfactual policy analysis. In particular, we found that, under the assumption that the bankrupt homeowners have similar profiles as in our model, policy reforms that “cramdown” mortgage loan obligations by making mortgage payments more affordable under personal bankruptcy will reduce foreclosure rates, but the effects are likely to be modest.
In summary, this article, to the best of our knowledge, represents the first indepth study of the homeownership experience of households in bankruptcy. It is worth noting that our analysis is limited in two important ways. First, although our bankrupt filers look very similar to those identified in other national studies, our results may not be generalized to the nation because our data came solely from Delaware, a state that is not representative of the nation in terms of bankruptcy provisions. In particular, Delaware has relatively strict bankruptcy and foreclosure laws. For example, in the 2001-to-2002 period, Delaware was one of only two states to have no homestead exemption.5 Furthermore, Delaware only admits judicial foreclosure with an average processing period of 190 days, among the highest in the nation. Delaware also permits deficiency judgments.
We will discuss these differences more in Section 2. Second and more importantly, given the data’s limitation, our policy analysis was conducted under the assumption that after policy changes, bankrupt homeowners will have similar economic profiles as those identified in our article. This assumption certainly does not hold in the current environment, where households are much deeper in debt. We hope, however, that the current ups and downs in the housing market are temporary. Thus, our results can be viewed as those in a stable real estate market.
In the remainder of the article, Section 2 addresses details regarding foreclosure and bankruptcy laws. Section 3 describes bankrupt households’ characteristics. Sections 4 and 5 report on these households’ homeownership experience and the determinants of their homeownership outcomes and resulting policy implications, respectively. Section 6 concludes the discussion.
Institutional Background Before our statistical analysis, we provide some institutional background concerning state laws that govern mortgage foreclosures and their interaction with federal personal bankruptcy laws.
Delaware had a wild-card exemption of $500. After the 2005 reform, the state increased the homestead exemption to $50,000.
Foreclosure Laws When a borrower defaults on a home mortgage, the lender may attempt to recover its losses by repossessing and selling the property. State property laws regarding the judicial foreclosure process, statutory rights of redemption, and deficiency judgments govern this act.
Two types of foreclosures are most commonly used. Foreclosure by judicial sale is available in every state, and it is the required method in many, including Delaware.6 Within a foreclosure by judicial sale, the mortgaged property is sold under the supervision of a court, with the proceeds going first to satisfy the mortgage, then to satisfy other lien holders, and finally to the borrower.
The second type of foreclosure is foreclosure by power of sale. In this type of foreclosure, the mortgage holder is permitted to sell the property without court supervision. Where it is available, foreclosure by power of sale is generally faster than foreclosure by judicial sale. In Delaware, the average process period is 190 days, which is among the longest in the nation.
After the foreclosure sale is complete, the homeowner can still regain the property if his or her state grants a statutory right of redemption. Homeowners can redeem their property for the foreclosure sale price plus foreclosure expenses for up to a year after the sale, depending on the state.
In Delaware, the homeowner has no right to redeem his or her property after the confirmation of the sheriff’s sale except for tax foreclosure. If the sale proceeds do not pay off the existing mortgage on the property plus costs, most states, including Delaware, allow the lender to collect a deficiency judgment equal to the lender’s foreclosure losses against the borrower’s other assets. For more details concerning Delaware’s foreclosure laws and their comparison with other states’ laws, see Li (2009), Table: State Foreclosure Laws—Comparison.
Homeowner Protection Under Bankruptcy Law The current personal bankruptcy law contains two chapters: chapter 7 and chapter 13. Filing for bankruptcy under either chapter imposes an automatic stay on all collection efforts by lenders, which includes foreclosure that is already in progress. Only the court can lift the stay during bankruptcy or after the bankruptcy case is terminated. The frequency of the two chapters depends heavily upon judicial district.
Chapter 7 discharges filers’ unsecured debt but requires them to surrender any assets that exceed state exemptions.7 Homeowners who have built up home equity face the risk that the trustee may sell the home and distribute any equity that exceeds the state homestead exemption to creditors.
Chapter 7 personal bankruptcy, nevertheless, has implications for mortgage protection. For example, discharging debt under chapter 7 affords borrowers who have not defaulted on their mortgages or who have worked out agreements with their lenders more available income to make their mortgage payments, thus protecting their homes from judgment liens.
Of the nation’s 50 states, only 15 disallow nonjudicial foreclosure; they are Connecticut, Delaware, Florida, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine, Nevada, New Jersey, North Dakota, Ohio, and South Carolina.
The federal personal bankruptcy law allows each state to set its own exemptions for various assets. If the filer has assets that exceed his or her corresponding legal exemption level, then he or she has to surrender the difference between his or her assets and the exemption level.
Unlike chapter 7, chapter 13 permits a defaulting mortgage borrower to propose a plan to cure a mortgage arrearage over time while continuing to make regular mortgage payments outside the plan. If the court confirms the plan, the automatic stay will protect the borrower until the plan is completed, the plan fails and the case is dismissed, or the plan is converted to chapter 7. In the latter two cases, lenders will often petition to have the automatic stay removed. A chapter 13 repayment plan typically lasts for 3 to 5 years. Even homeowners with substantial equity can save their homes by making more payments to unsecured creditors instead of selling their houses as they might have to under chapter 7. Therefore, chapter 13 overrides lenders’ contractual and legal rights to pursue foreclosure. For the remainder of the article, we concentrate on chapter 13, because it provides the stronger form of mortgagor protection.8 Bankrupt Households’ Characteristics Our data come from four different sources. The main data set contains information on all chapter 13 personal bankruptcies that were filed between August 1, 2001, and August 1, 2002, in New Castle County, Delaware. We collected these data using an electronic service that grants public access to case and docket information from federal bankruptcy courts and the U.S. Party/Case Index, commonly known as Public Access to Court Electronic Records, also known as PACER. This service offers bankruptcy court information, including (1) a listing of all parties and participants, including judges, attorneys, and trustees; (2) a chronology of all events entered in the case record;
(3) a claims registry; and (4) the types of documents filed for specific cases and imaged copies of these documents.