Newswise — Few Americans who struggle with high housing costs will be able to save their homes by filing for bankruptcy because of limitations in federal bankruptcy law, new research by University of Iowa law professor and bankruptcy researcher Katie Porter suggests.
Porter said the fate of many homeowners is "grim" because most don't earn enough income to make the monthly payment on their mortgages.
More than 70 percent of homeowners who filed Chapter 13 bankruptcy in Porter's study live in unaffordable homes, which means that even if they stave off foreclosure for now, most still won't be able to afford their monthly payment in the future.
"Chapter 13 is a powerful tool for helping families get caught up on missed payments of their home loan, but does nothing to address the future affordability of their mortgage," said Porter. "As a result, without a significant increase in income, many of these homeowners will have a difficult time finding the dollars to pay their mortgages. This jeopardizes their chances of completing their bankruptcy and exposes them to a high likelihood of foreclosure."
Porter's study examined 1,733 Chapter 13 bankruptcy filings by homeowners in April 2006. The research showed that 50 percent of them live in homes that meet federal guidelines as unaffordable, which means they consume between 30 percent and 50 percent of a household's monthly income. An additional 21 percent of filers live in homes defined as severely unaffordable, which means they consume more than 50 percent of the household's monthly income.
The Obama Administration recently identified 31 percent of gross pay devoted to housing as the appropriate benchmark for modifying mortgages. But Porter said that even when using gross income, only half of all homeowners in bankruptcy have homeownership costs below the 31 percent threshold.
Only 28 percent of the filers live in homes that meet federal guidelines for affordable housing, she said.
Complicating the issue is the fact that most of those who file for bankruptcy protection have low incomes. In Porter's survey, the median annual income of a bankrupt family was $43,000, well below the $65,000 national average.
"Chapter 13's requirement of living on a strict budget for three to five years will pose a formidable challenge to families in unaffordable or severely unaffordable housing," Porter said. "Without the ability to modify the terms of their mortgages, an option available in bankruptcy for other kinds of secured debt, many families will lose their homes to foreclosure despite bankruptcy."
The implications extend beyond the debtor losing a home, however. She said it increases the likelihood of a homeowner re-filing for bankruptcy, driving up the number of cases in an already clogged legal system.
Porter said some of these homeowners might be able to pay their future mortgages if the bankruptcy court were able to set up a new payment schedule between the homeowner and the lender, a process known as "cram down." But an anti-modification rule in federal bankruptcy law prohibits such action in almost all cases.
"Bankruptcy law does not permit debtors to modify the terms of mortgages, and this limitation on restructuring the loan may pose an insurmountable barrier to families who are trapped in unaffordable loans," she said.
Porter said Congress should re-write bankruptcy laws to permit the modification of mortgages in bankruptcy to help families save their homes from foreclosure.
Porter notes that her study's sample consists of bankruptcy cases filed in 2006, before the recent explosion of foreclosures. Since many of today's foreclosures are being brought on by the widespread use of such non-traditional credit vehicles as sub-prime loans, and the loose underwriting standards used to approve many of those loans, she speculates that families are actually having an even more difficult time staying in their homes than her study documents.
Porter's paper, "Saving Homes in Bankruptcy: Housing Affordability and Loan Modification," was published in Volume 3, Issue 2008 of the Utah Law Review. It was co-authored by John Eggum, a recent graduate of the UI College of Law, and Tara Twomey, a lecturer at Stanford Law School and consultant to the National Consumer Law Center.
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