There was a time when a homeowner facing the loss of a house due to foreclosure could stave it off by filing for bankruptcy protection. No more.
While the number of foreclosures has been soaring, the number of bankruptcy filing is down drastically following a bankruptcy reform act passed by Congress in late 2005. As a result, debtors apparently no longer believe that bankruptcy is an option for them, even though the basic rules about what to do to keep a house are the same under the new law, according to legal experts.
“I suspect there is a misperception about the viability of using bankruptcy,” said Terry Miller, clerk of the Federal Bankruptcy Court in Phoenix. “I can’t point to any statistics, but we suspect people who are in those circumstances (facing foreclosure) are not coming in and filing at the same rate as they used to.”
The statistics do show a divergence. Home foreclosure filings were up 128 percent in Arizona and 56 percent nationwide in the first half of this year compared to the same period in 2006, according to RealtyTrac, a marketer of foreclosed properties. But bankruptcy filings are drastically lower this year than in 2004, the most recent comparable year before the new bankruptcy law took effect.
According to the U.S. Bankruptcy Court in the District of Arizona and the American Bankruptcy Institute, filing this year will be down 70 percent in Arizona and 50 percent nationwide compared to 2004.
The new law, the Bankruptcy Abuse Prevention and Consumer Protection Act, designed to correct perceived abuses in the filing of bankruptcy cases, does make bankruptcy filings more expensive and complex, Miller said.
Among its new requirements are that an individual complete a consumer credit counseling program before filing; that the individual pass a means test to determine if his income, assets and debts qualify him for a Chapter 13 (restructuring) or Chapter 7 (liquidation) and that the filer complete a financial management program before discharge.
Also, filing fees in Arizona for Chapter 7 have increased from $209 to $299, and filing fees for Chapter 13 have increased from $194 to $272, Miller said.
Still, comparing the fees and the aggravation against the potential amount of debt that could be discharged, the outcome could still be worthwhile for many people with severe financial problems, he said.
In Arizona the bankruptcy court has been stepping up education programs to inform more people about the new law and the bankruptcy process, revamping the Web site to make more information available online and reaching out to rural communities such as Florence, Prescott and Bullhead City.
There are indications that a turnaround is taking place, although that may have more to do with the weakening economy than to increased public knowledge about the new law, Miller said.
August was the first month since the reforms went into effect that the number of bankruptcy filings statewide exceeded 1,000, he said. The number of filings so far this year is up 62 percent from the same time period last year, although they still are far behind the pace of 2004 and 2005, he said.
But experts say other factors may be at work to discourage bankruptcy filings as a means to avoid foreclosure. A lot of the nation’s mortgage woes have been caused by declining home values and upwardly adjusting interest rates.
With the resetting of adjustable rate mortgages at higher rates, some borrowers can’t afford to keep making mortgage payments.
But the bankruptcy process requires the debtor to continue to make payments, although sometimes the payments can be restructured to make them more affordable, said Anthony Sanders, a professor of finance and real estate at the W.P. Carey School of Business at Arizona State University.
“If you can make the payments, bankruptcy is better,” he said. “It’s the process to use if you want to stay in your home. Foreclosure is a surrender strategy.”
That could be a strategy that’s just fine for owners who purchased homes for investment purposes and intended to “flip” the property — resell it for a profit during a period of rising home values — rather than live in it, said Dawn McLaren, economist for the W.P. Carey School.
If they are financially strapped, they might be more likely to just cut their losses and let the property fall into foreclosure rather than accept the stigma of bankruptcy, she said. The live-in home owner, on the other hand, might be willing to accept bankruptcy to keep a roof over their heads, she said.
Ultimately, the decision on whether to file for bankruptcy to save a house or to allow it go into foreclosure depends on the circumstances of the debtor, she said.
“There is some protection in bankruptcy against having to deal with creditors who are hounding you,” she said. “It’s the cost versus the benefits.”