Bankruptcy vs. Foreclosure

Discussion in 'Homesteading Questions' started by primroselane, Oct 10, 2004.

  1. primroselane

    primroselane Well-Known Member

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    MICHAEL A. KNOX thought he had run out of ways to pay off his credit card bills when he got the salesman's call two years ago. To wipe out his nearly $20,000 debt, he was told, all he had to do was take out a new, bigger mortgage on his house.

    Mr. Knox, then 60 and on disability, signed up. The mortgage broker sent him eight checks already made out to his creditors, and Mr. Knox dashed to the post office the day they arrived to mail them.

    But the bigger house payment devoured 75 percent of his income. He quickly fell behind. And the full meaning of what he had done suddenly became clear.

    By using his mortgage to pay off his credit card debt, Mr. Knox had avoided the humiliation of filing for bankruptcy. But he had put at risk something much more important to him than his pride. In late January, with Mr. Knox in arrears, the Wall Street firm that had bought his mortgage informed him that it was taking away his home.

    "They're going to have to carry me out of here," he told a lawyer in early March. Days later, Mr. Knox, who had suffered for years from depression, was found dead of carbon monoxide poisoning in his sealed-up car.

    Encouraged by low interest rates and rising home values, millions of Americans have been using their homes to pay off credit card bills. One-fourth of homeowners who refinanced their mortgages took out larger loans on their homes in order to pay off credit cards and other debts, according to a recent study by the Federal Reserve.

    The maneuver is known as debt consolidation, and mortgage lenders are using national campaigns - from prime-time advertising to e-mail spam - to pitch it as a sound way to ease the sting of credit card debt, which averages $13,000 for people who don't pay off their balance each month, according to CardWeb.com. For many, probably a vast majority, it has been a boon. Experts say the device is a factor in a recent leveling off of credit card debt and a drop this year in personal bankruptcies.

    But each year, tens of thousands of people - not just the poor - lose their homes after trying to cope with their debts this way, industry figures show, and their heart-rending tales are raising alarm among consumer advocates, federal regulators and some mortgage lending officials.

    In Bluefield, W. Va., a retired coal miner, William Anderson, 80, and his wife, Kathleen, 79, owned their home of 45 years free and clear, but lost it in March after falling behind on a new $48,000 mortgage that they were persuaded to get in order to pay off their automobile loans.

    Robert and Shirley McCall of Paris, Ill., were trying to pay off $7,720 in medical bills when they took out a new $22,000 mortgage on their house, but in failing to keep up with the larger mortgage payments, they were warned by their lender in August that they were nearing foreclosure.

    In Macon, Ga., Melissa and Shawn Lynch are trying to salvage their home. In order to pay off credit card debts, they took out a second mortgage on the three-bedroom home they bought in 2001 for $71,000, but then were hit with medical bills on top of the new, larger mortgage payments. Three weeks ago, they sought help from a debt counselor and discovered that their house was at great risk. "We were young," said Ms. Lynch, 28, and the lender "smelled blood, really."

    While not everyone affected is a poor credit risk, much of the booming business of debt consolidation focuses on such borrowers - what is known as the subprime market.

    The industry, which has an estimated four million outstanding loans, has enabled many people with modest incomes to own their homes. But last year, more than 16 percent of subprime mortgages were delinquent or in foreclosure. More than 76,000 families with subprime mortgages tumbled into foreclosure in the first quarter of 2004, and an additional 47,000 in the second quarter.

    While statistical evidence is piecemeal, the rush to pay off credit cards and other consumer debt by taking out bigger mortgages appears to be playing a growing role in this trouble.

    Many people who refinance mortgages, of course, do so simply to lower their house payments. But the people who refinance for extra cash are as much as twice as likely to lose their homes through foreclosure than those who refinance for other reasons, according to statistics from the PMI Group, a major mortgage insurer. And most subprime loans being made today - estimates run as high as 70 or 80 percent - are debt consolidation loans like Mr. Knox's.


    "Financing credit card debt on your mortgage, in general, is a bad idea," Edward M. Gramlich, a Federal Reserve governor, said in an interview last week. "With the credit card debt you can go into bankruptcy, but if you put it on your mortgage you could lose your house, and that happens a lot."

    Policy makers see the very existence of these debt-consolidation loans as the next issue in their battle with the subprime lending industry, which until now has been criticized largely about its high costs, prompting new state and federal laws.

    Some industry officials say lenders have pushed too hard in selling dangerous loans to vulnerable homeowners who may not fully appreciate the risks. Larry Litton Jr., the chief operating officer of Litton Loan Servicing, based in Houston, which collects mortgage payments on behalf of lenders, said that most of the delinquent subprime loans he was handling involved debt consolidation and borrowers who did not realize that they would go back to running up more credit card debt unless they found some way to balance their income and expenses.

    "Even though, conceptually, debt consolidation is used to retire debt, it often leads to increased debt burden," he said. "People make decisions sometimes that aren't real rational whenever it comes to incurring debt. I sure hate for people to draw conclusions that these people are irresponsible as a drug addict, but they are similar in the sense that debt can be very addicting."

    William C. Apgar, an assistant housing secretary in the Clinton administration, said that homeownership "can't be used as an everlasting reserve fund for folks who have more expenses than income on a perpetual basis."

    But as the case of Michael Knox shows, many homeowners do use mortgage refinancing that way and some lenders have sold the maneuver aggressively to people hooked on the promise of easy credit.

    Mr. Knox's story, pieced together from financial documents and from the increasingly despairing letters he wrote to company officials, regulators and others, is a particularly sad look at this dark side of the mortgage refinancing boom.

    Mr. Knox may have seemed like someone you would not want to lend money to. But by the logic of the subprime market, he looked like a desirable customer.

    Subprime lenders charge higher-than-usual interest rates and can protect themselves by selling the loans to Wall Street, which in turn consolidates large numbers of loans into investment pools and markets them to investors worldwide in the form of asset-backed bonds.

    But experts say that the market is susceptible to overzealous salesmanship and, sometimes, fraud.

    Mr. Knox had already refinanced twice in six months when he got the call from an Aames Financial broker. In qualifying Mr. Knox for a $90,000 mortgage at 9.23 percent that he ultimately could not afford, company records show, Aames waived its own rules for verifying income and employment. The mortgage was also based on an assessment of his house that was considerably higher than an official county estimate.

    Aames, a medium-size lender based in Los Angeles, said it had done nothing wrong in lending money to Mr. Knox, particularly because he had almost always paid his bills on time. As Aames pointed out to an arbitrator who ruled in its favor after Mr. Knox filed a complaint, "No one was pointing a gun to his head to do it." More broadly, the company said it had stringent measures to avoid problem lending, including a system adopted last year to determine whether borrowers would truly benefit from its loans.

    In April, the company disclosed that it was cooperating with a Federal Trade Commission inquiry into subprime lending practices nationwide. And in Iowa, the state justice department is investigating Mr. Knox's case, saying that it may show that the lending industry is undermining homeownership by pushing too hard for growth.
     
  2. sidepasser

    sidepasser Well-Known Member

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    I see a lot of banks touted the so called "home equity" loan as a way to pay off credit card debt. Might work in the short term, but in reality, a person is trading unsecured debt for secured debt and may eventually be unable to pay both the mortgage and the home equity loan. Not a good deal in my book unless you use the home equity loan to make improvements in the home itself.

    Never trade unsecured debt for secured debt, especially your home.

    sidepasser
     

  3. pcdreams

    pcdreams Well-Known Member

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    very sad situation.

    However a lot of these case could be avoided all together if people would learn to live within their means.

    to much "keeping up with the Jones" if you ask me..
     
  4. kosh

    kosh Well-Known Member

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    I think it can be a constructive thing, if done right. I went through a period, where money was very tight, I had to buy a new vehicle (the other was dying and I drive far to work everyday so i needed a new vehicle), because of some other financial situations that came up, ended up needing to use credit cards for everyday expenses such as food and gas. One of the best things i did was refinance the house. I got a lower interest rate (by a few points), paid off the vehicle loan, and the credit cards. My monthly payment for the house stayed nearly the same, i think it went up perhaps $100, (even though a lot of money was added on to the principal balance, the interest rate was lower, so it was a wash). I no longer had the other payments and was able to live better, shortly after that i got a new job that was still far away, but better paying.

    So if it's done right it can be good.

    Peace,
    Jason
     
  5. amelia

    amelia Well-Known Member

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    I'm not sure that this article isn't itself a little deceptive. . . Bankruptcy hardly guarantees that you can save you home. In the typical bankruptcy situation, your home is not "exempt." Instead, you're going to get a "homestead exemption" of whatever amount you state allows (here in Washington it was $35-$40,000 the last time I checked). That's not going to be enough to allow you to keep a home worth significantly more than that.

    Furthermore, there's nothing magical about unsecured debt in terms of your ability to protect your home from creditors. Granted, an unsecured creditor is required to jump through a few more hoops than the holder of a mortgage or a deed of trust--he must get a court judgment and then go through procedures to execute it--, but that's hardly a difficult thing to do. In fact, an unsecured creditor jumps for joy when a search of the real property records turns up a house with some equity.

    What's wrong with trading an 18 percent credit card debt for a 5 percent mortgage loan? Granted, I wouldn't recommend that move for a person who could not afford to pay even the reduced interest of a mortgage loan. But for many people, the difference between paying 18 percent interest and 5 percent amortized over 30 years spells the difference between a totally impossible situation and a manageable monthly obligation.

    Just a thought.