Now You See It, Now You Don't

May 9, 2011 4:02 PM

Homeowners are using a little known loophole in the bankruptcy laws to shed their second mortgages.
posted by reenum (42 comments total)

Homeowners are using a little now well known loophole in the bankruptcy laws to shed their second mortgages.

ftfy.
posted by nzero at 4:13 PM on May 9, 2011 [3 favorites]

I was on the fence about whether to like this or not, but...

Mortgage bankers don't like the practice.

...pretty much sealed the deal.
posted by dixiecupdrinking at 4:13 PM on May 9, 2011 [29 favorites]

It's not a loophole. It's not little-known. It does not allow you to "shed" a mortgage. Three for three - about average for American reporting.
posted by Nothing at 4:16 PM on May 9, 2011 [6 favorites]

I like these mortgage tricks. I'm using the "show me proof you own the note" trick to stomp my usurious former credit card company into the ground. Miraculously, the $9500 figure they just pulled out of their ass went back down to the actual $2000. And they can't even prove they own that note.
posted by charlie don't surf at 4:19 PM on May 9, 2011 [10 favorites]

On one hand, this screws over banks. On the other hand, this gives rich people who can afford a second home an easy out, which also ends up screwing the rest of us, since we have to cover their risk with higher insurance premiums and borrowing rates on single homes.
posted by Blazecock Pileon at 4:20 PM on May 9, 2011 [1 favorite]

It's a feature, not a bug. This is exactly how personal bankruptcy should work. Although I wouldn't be surprised to see the mortgage banking industry push to change the rules.

Why do individuals need bankruptcy protection anyways? They knew what they were signing up for! Why should they be rewarded for their bad choices? hamburger
posted by Arbac at 4:22 PM on May 9, 2011

The thing is, the first mortgage on the house is still being paid off. Because the second mortgage is secured by your house's equity, it only has security as long as your house is worth more than your first mortgage. Otherwise, if you house is worth less than your first mortgage, a second mortgage is basically just unsecured debt, which is dischargable in bankruptcy. (You have to have made a deal to work out the payment on your first mortgage for this to work, though.)

Some mortgage bankers don't like the practice.

FTFY

It's not a bad thing for mortgage bankers. It protects the security of first mortgages, but discharges second mortgages. So, if you're in the business of lending first mortgages, then it's good that a second mortgage lender can't steal your security out from under you. Notice that the California Mortgage Bankers Association seems to dislike it, but the Association of Mortgage Investors likes it just fine.

Note also that this doesn't cover refinancing. It only helps in the limited circumstance that a person has a second mortgage on their home. I've never had to take out a second mortgage, and would questions why it would be necessary (obviously, paying medical debts is a good reason), but I'm not sure how useful this is to the average homeowner.
posted by jabberjaw at 4:24 PM on May 9, 2011

^ Just wanted to further explain I do believe that there are many legitimate reasons to take out a second mortgage, and I don't know the circumstances in the case illustrated.
posted by jabberjaw at 4:26 PM on May 9, 2011

Note also that this doesn't cover refinancing. It only helps in the limited circumstance that a person has a second mortgage on their home. I've never had to take out a second mortgage, and would questions why it would be necessary (obviously, paying medical debts is a good reason), but I'm not sure how useful this is to the average homeowner.

It was pretty common practice during most of the Twenty-ohs for people with a good amount of their first mortgages paid (and thus having equity in their home) to take out a second mortgage for things like major purchases or home remodeling projects. The whole "use your house like a piggy bank" mentality was developed during that time, and is probably more common than your individual experience suggests.
posted by hippybear at 4:28 PM on May 9, 2011

It's bizarre to characterize this as a "loophole". It's a second mortgage; by definition, it's not well secured.
posted by Nelson at 4:28 PM on May 9, 2011 [1 favorite]

Three for three - about average for American reporting.

You can forgive the journo for being confused, perhaps:
"It's a big thing in our valley," said James "Ike" Shulman, a San Jose bankruptcy lawyer. "But it's not widely known."
posted by entropone at 4:41 PM on May 9, 2011

VENKMAN: You'll never regret this, Ray. 
STANTZ:  My parents left me that house, I was born there. 
VENKMAN: You're not going to lose the house.  Everybody has three mortgages these days. 

posted by ceribus peribus at 4:44 PM on May 9, 2011 [7 favorites]

It's "a troublesome phenomenon. It's one of those things that's just now developing and bubbling up," said Dustin Hobbs, spokesman for the California Mortgage Bankers Association

That's rich.
posted by Max Power at 4:45 PM on May 9, 2011 [1 favorite]

. On the other hand, this gives rich people who can afford a second home an easy out, which also ends up screwing the rest of us

Second mortgages on primary homes. Not mortgages on second homes.
posted by delmoi at 4:47 PM on May 9, 2011 [2 favorites]

Now this is some terrible reporting.

BREAKING NEWS: juries taking advantage of little-known loophole that allows people to be acquitted in the presence of reasonable doubt.
posted by allen.spaulding at 4:50 PM on May 9, 2011 [3 favorites]

The whole "use your house like a piggy bank" mentality was developed during that time, and is probably more common than your individual experience suggests.

Ah. That's a bummer, for everybody involved.
posted by jabberjaw at 4:54 PM on May 9, 2011

Ah. That's a bummer, for everybody involved.

There was even a series of television commercials, I believe from Countrywide, which actually used an image of a house morphing into a piggy bank as part of its imagery.
posted by hippybear at 5:00 PM on May 9, 2011

If anyone is getting low on brain-space but really wants to experience this again you can probably just sort of randomly reread the comments from some older posts of metafilter past.
posted by floam at 5:11 PM on May 9, 2011 [1 favorite]

Yea, this is pretty much how bankruptcy law works. Creditor's claims are often discharged entirely, that's the whole fucking point.

So can we all agree this is another "it's all the poor/irresponsible/deadbeat/black/mexican/welfare/FHA homeowners fault" story, likely planted by the banks?

Got it. Seems these plant stories pop up on metafilter pretty often these days. Intentional Astroturf or effective brainwashing taking hold in the public consciousness, we post, you decide!
posted by T.D. Strange at 5:28 PM on May 9, 2011 [2 favorites]

"little known loophole"... sounds like the wording of some of the worst on-line ads I don't bother to block: "three weird rules!!!" "one simple trick!!!"

I'll bet the Mercury News gets a few extra full-page ads from the bigger banks in exchange for that story.
posted by oneswellfoop at 5:32 PM on May 9, 2011

So the journalist's LinkedIn profile implies that he's either in his late sixties or early seventies. So it's entirely possible that his knowledge is based on pre-Mexican war civil law in California. Although even then he probably fucked up the central point on a simple piece about one of the largest sectors of the largest economy the world has ever known.

Some journalists can't be neutral on a derailed train, they're too busy throwing poor people into the coal burner while blaiming them for everything.
posted by allen.spaulding at 5:36 PM on May 9, 2011 [1 favorite]

In addition to all the various other points on how this is standard bankruptcy law, many people in the Bay Area were unable to even buy homes without a second mortgage because of the crazy price of real estate here. often these people simply had two mortgages to buy one house and now that the house is underwater they're paying their first mortgage which has a value closer to the true value of the house. So this is effectively the same as getting your initial mortgage renegotiated on an underwater house.
posted by GuyZero at 5:42 PM on May 9, 2011

It is called the "firebox".
posted by ryanrs at 5:49 PM on May 9, 2011 [2 favorites]

Homeowners are using a little known loophole in the bankruptcy laws to shed their second mortgages. Second Mortgages Not Secured by Equity Treated, Sensibly and Lawfully, As Unsecured Debt.

FTFY.
posted by gauche at 5:53 PM on May 9, 2011 [2 favorites]

It's bizarre to characterize this as a "loophole". It's a second mortgage; by definition, it's not well secured.

Right on the first, but of course as long as real estate values are rising the second mortgage is in fact secured. It's in those unusual times like these when they're falling that it becomes unsecured by the diminished value of the residence.

The mortgages aren't really "voided", they are discharged like all debt at the completion of the bankruptcy. It is, however, the case that many Chapter 13 plans do not actually complete and achieve full discharge, because of the time it takes to pay off the debt agreed to in the original filing. People get divorced, lose jobs, lose their health, even die. But for those who can complete the bankruptcy, it works properly.
posted by dhartung at 6:07 PM on May 9, 2011

There isn't any other system for handling these second mortgages anyways. If the homeowner defaults, the primary mortgage holder takes the house, which they don't actually want, and the second mortgage holder still gets zilch, right? In this way, people keep their home, the first mortgage holder keeps getting payments, and it costs the second mortgage holder nothing more than a default.
posted by jeffburdges at 6:09 PM on May 9, 2011 [1 favorite]

jeffburdges, in a default sans bankruptcy, the mortgage holder can theoretically sue the (broke) note holder for the deficiency -- but then they will probably go Chapter 7, and what they get will again depend on the assets of the debtor. In the past such lawsuits were rare, but I've heard they have been used more and more recently.
posted by dhartung at 6:39 PM on May 9, 2011

So can we all agree this is another "it's all the poor/irresponsible/deadbeat/black/mexican/welfare/FHA homeowners fault" story, likely planted by the banks?

No. there's one brief quote from a representative of the banking industry expressing their dislike of the practice. How you and other posters parlay that into the article being an attack on the poor is beyond me. Please, quote us some of the offensive remarks in the article so that we have a clear idea of what you are objecting to.
posted by anigbrowl at 7:06 PM on May 9, 2011 [1 favorite]

On the other hand, this gives rich people who can afford a second home an easy out, ...

Blazecock Pileon, delmoi already explained why you got the "second home" part wrong.

The "rich people" part is wrong, too: virtually anyone who owned a house, and either (A) had paid significant amounts on the first mortgage, (B) had a sizeable downpayment (much greater than the usual 20%), or (C) had their house reappraised during the market bubble, could take out a second mortgage. Many, many people did. It was a low-interest loan; beats the hell out of a high-interest loan.

2nd mortgages don't correlate with high incomes, nor even fatuously living beyond one's means (necessarily).
posted by IAmBroom at 7:06 PM on May 9, 2011

Meanwhile, in Spain, just the opposite:

But Mr. Marbán does not own either anymore. The bank foreclosed on both properties last April, and he is waiting for the courts to issue the eviction notices. For many Americans facing foreclosure, that would be the end of it. But for Mr. Marbán and thousands of others here, it is just the beginning of their troubles. When the gavel falls on his case, he will still owe the bank more than $140,000. “I will be working for the bank for the rest of my life,” Mr. Marbán said recently, tears welling in his eyes. “I will never own anything — not even a car.”
Not only are Spanish mortgage holders personally liable for the full amount of the loan, but throw in penalty interest charges and tens of thousands of dollars in court fees, and people can end up, like Mr. Marbán, facing a mountain of debt. Bankruptcy is not the answer, either. Mortgage debt is specifically excluded here.

“Effectively, you can never get rid of this debt,” said Ada Colau, a human rights lawyer who works for Plataforma, a new advocacy group formed both to give legal advice to homeowners...
posted by 445supermag at 7:10 PM on May 9, 2011 [2 favorites]

Second mortgages on primary homes. Not mortgages on second homes.

I assumed maybe he was getting at people who use second mortgages to buy second homes.
posted by floam at 7:15 PM on May 9, 2011

“Effectively, you can never get rid of this debt,”

Time to pack up and emigrate to an undisclosed country, I'd say.
posted by DreamerFi at 11:44 PM on May 9, 2011 [1 favorite]

Meanwhile, in Spain, just the opposite:

Holy shit that is fucked up. So the bank gets the property and then the debtor has to pay them back as well? That doesn't even make any sense.

Thank God the US has slightly more sane bankruptcy laws. I personally thank Thomas Jefferson for owing so much money to the British and the French.
posted by Aizkolari at 3:45 AM on May 10, 2011

Holy shit that is fucked up. So the bank gets the property and then the debtor has to pay them back as well? That doesn't even make any sense.

That's how it works almost everywhere in the world. I was astonished when I found out that mortgages in some US States were non-recourse.
posted by A Thousand Baited Hooks at 6:13 AM on May 10, 2011

That's how it works almost everywhere in the world.

Quoted for truth. For some in the US, declaring bankruptcy is almost a source of pride. In other countries it means that you are well and truly fucked for a very, very long time. There's very little forgiveness and it's a social stigma.
posted by ob at 7:39 AM on May 10, 2011

For some in the US, declaring bankruptcy is almost a source of pride.

I hope I'm not being fighty, but I hear people say variants on this a lot and I really don't see how it advances the conversation. You might as well say, "for some in the U.S., screwing homeowners out of their homes is almost a point of pride", or "for some in the U.S., releasing toxic chemicals into the groundwater without compensating the people who have to drink that water for their inevitable cancers, birth defects, &c., is a business strategy" or "for some lenders, offering a second mortgage while knowing that the second mortgage could be crammed-down in bankruptcy, under certain circumstances, was a risk they were willing to take".

There are a lot of problems with how mortgages have been written in the last (say) 10 years; there are a lot of problems with how property values have been artificially inflated; there is a lot of bad acting to go around. One thing that I figure, though, is that institutional lenders, much more than homeowners, had incentives to know the risks of their investments. The cramdown mechanism is well-known in bankruptcy law and homeowner lending — I learned it somewhere in my three month bankruptcy internship, for instance. Lenders who didn't price this risk into their lending are lenders who did not do their due diligence. Whatever pride some people may have in declaring bankruptcy, the lenders who wrote these loans should have priced that into their lending as well. If the market is functioning as it should, those lenders who weren't smart enough to do that should fail.
posted by gauche at 8:46 AM on May 10, 2011 [1 favorite]

The stereotype of bankruptcy as a source of pride is rooted in the widespread phenomenon of people starting a business, not making a go of it (because it's their first attempt and they don't know what they're doing), and declaring bankruptcy in order to start over. The phenomenon of mass bankruptcy due to soaring medical costs or plummeting real estate values is relatively recent.

In Europe, on the other hand, declaring bankruptcy is the financial equivalent of leprosy. The idea that someone could go bankrupt and then make good with another business is unthinkable. This is not to say that never happens, but it is really looked down upon. Since there is a reasonably generous welfare state, the thinking goes, why would you want to start a business, especially one you turned out unable to manage? Obviously you must have been selfish and greedy to begin with, or you wouldn't have allowed yourself to be seduced by visions of wealth and status. Being a member of the merchant class, even a financially stable one, is seen as slightly distasteful by a great many people.
posted by anigbrowl at 9:01 AM on May 10, 2011

That's a good point, and one that bears repeating. Having a "fresh start" out of bankruptcy is good for the economy.
posted by gauche at 9:06 AM on May 10, 2011

Forgot this bit...

If the market is functioning as it should, those lenders who weren't smart enough to do that should fail.

What do you think all those FDIC bank closures and forced mergers were about? A lot of banks have failed. We bailed out a few of the very biggest financial institutions because if we hadn't, the entire payments system might have collapsed. Your paycheck, if you receive one, becomes a worthless piece of scrap paper, the ATMs don't give out cash, and plastic doesn't work at the supermarket. Collapses of the banking system don't end up with a few bankers jumping out of windows and a few more having their heads chopped off, after which everything goes back to normal. They end in riots and famines, sometimes civil war or oppression. It is not in any way a good thing, and anyone who says otherwise is either an idiot or an authoritarian on the make.
posted by anigbrowl at 9:08 AM on May 10, 2011

I think we're on the same side here. One of the bad things about the Bush years was that the administration and Congress went along with bankruptcy 'reform' that made it much more difficult for individuals to restructure their debts and start over, at the behest of the financial industry. If I remember correctly, MBNA pretty much wrote the legislation.

Without that change, the real estate bubble would have burst earlier and more gently because bankruptcy (old style) provided a more forgiving exit, so people had less incentive to double down and refinance and mortgage that was proving too difficult to manage. I think we're about to see the same phenomenon with educational loans, but that's another story.
posted by anigbrowl at 9:15 AM on May 10, 2011

I think we're on the same side here, too. I get the catastrophic risk that comes from the collapse of the banking industry, and (for what it's worth) I was in favor of the bailout in 2008 as the best of bad options. Having said that, I think it's important to preserve the rights of homeowners under the bankruptcy code.

The problem with the bank bailout is that it did both what it's supporters and its detractors said it would: it both staved off a major economic collapse, and protected institutions that should have failed without creating disincentives for those institutions to continue to consolidate. As we are living in the aftermath of our solution (which is likely better than the alternative would have been), I think more and more that treating the bankruptcy cram-down as a "loop-hole" and not a right of homeowners only sets us up to shift even more wealth — and less risk — into the hands of lenders. I'm not at all comfortable with that.
posted by gauche at 11:33 AM on May 10, 2011

For some in the US, declaring bankruptcy is almost a source of pride.

As a nation, we pride ourselves on our business leadership's pioneering exploration of morality & ethics, and our ability to apply their lessons learned in our own lives.
posted by jeffburdges at 2:17 PM on May 10, 2011