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Hybrid ARM Mortgages – Have You Been Misled?

By Jonathan on July 27, 2006

I recently took notice of a post on Kevin Chern’s Bankruptcy Lawyer’s Blog in which he wrote about the “ARM boom” of the early 2000’s and how almost $1 trillion of ARM loans would adjust (upwards) in 2006 and 2007.

The bankruptcy implications of these ARM adjustments will be numerous, including:

some homeowners will not be able to afford to stay in their homes
bankruptcy relief will be more difficult to obtain because of burdensome changes to the bankruptcy filing rules
Chapter 13 repayment plans will necessarily become very complex, requiring on-going plan adjustments by bankruptcy counsel, and increased bankruptcy legal and administration costs.

With the proliferation of radio and tv ads from mortgage brokers encouraging homeowners to refinance (more recently I am hearing ads extolling the virtues of repeated refinancing “without closing costs” whenever interest rates dip downward), I wonder if any of these mortgage brokers or the mortgage lenders themselves fully explain what it means to purchase an adjustable rate mortgage or a hybrid adjustable rate mortgage.

Professor Elizabeth Warren, in the Credit Slips blog notes that more and more ARM mortgagees simply roll into a new ARM when the rate adjusts, but that when housing prices level out, these refinancing opportunities will disappear, leaving the homeowner with no equity and the loss of the home or bankruptcy.

It seems to me that the popular hybrid ARM loans have the most potential for trouble. In a hybrid, the mortgage rate is fixed for a set period of time (perhaps 2 to 5 years) then it becomes adjustable. The problem from my perspective as a bankruptcy lawyer is that most people budget based on their income and expenses today. When that mortgage becomes adjustable in 5 years, these families are already tied into car notes, furniture debt, and other monthly obligations and they cannot absorb an extra $500 or $800 a month.

In other words, sellers of hybrid ARMS take advantage of the short term thinking that exists in just about every market, including real estate. And the dozens of disclosures mandated by federal law don’t really serve any purpose as no one reads them and closing attorneys zoom through them without any real explanation.

Rather than seeing your home as a long term, “permanent” purchase, sellers of mortgage products have subtly chaged terms of the discussion. Here is the pitch for a hybrid ARM from a popular mortgage site:

The ideal mortgage for such borrowers is one that has a fixed rate for an initial period of years that coincides with the borrower’s intended time horizon in the home. Only then does the rate become adjustable. What results is a mortgage that has a fixed rate for the time the homeowner expects to occupy the home, with any rate adjustments not due until after the homeowner intends to move on. The clincher is that the initial fixed rate is lower than what is found on a traditional 30-year fixed rate mortgage. (emphasis added)

How many of us can say with any degree of certainty what our “intended time horizon” for living in our home will be? Given that most of your mortgage payment during the first 10+ years goes to interest, and transaction costs are usually rolled into the mortgage balance, who really benefits when homeowners do not stay in one place for more than a few years? Certainly not the homeowner.

Clearly, each of us is responsible for making our own decisions about when and where to buy a home and how to finance that purchase. Speaking from the perspective of a bankruptcy lawyer, however, I think that far too many people end up in my office because they have not thought through their decisions carefully.

Recently, a writer for a well known business magazine contacted me to ask if I knew of any homeowners who felt that they had been misled by either their mortgage broker or a mortgage lender when entering into a hybrid ARM mortgage loan. If you fall in this category and would be interested in speaking to this reporter, please email me or call me and I will put you in touch.

Potential Debtors from Any State Will Find Helpful Information on Iowa Bankruptcy Lawyer’s Web Site

By Jonathan on July 21, 2006

Although I practice law in Georgia, I spend as much time as I can looking at bankruptcy web sites from all over the country because of my interest in the subject and because I regularly work with lawyers as a web site development consultant. I know how much work goes into creating high quality web sites through my own work on my Atlanta bankruptcy site and so when I see a well done site here in Georgia or from another jurisdiction, I have no reluctance to recommend that you use these sites written by my colleagues as part of your research.

Iowa attorney Jeff Mathias has developed an excellent web resource with his DeMoinesBankruptcy.com site, and I recommend that anyone who is considering bankruptcy take a look.

Jeff does a very nice job breaking down the bankruptcy research process, with sections about bankruptcy myths, bankruptcy mistakes and information written specifically for individuals and for small business. It is also clear that Jeff realizes that people who are facing financial hardship are looking for accurate, unbiased and comprehensive information, not a hard sell or buzz words.

Cars With Starter Lockouts and Chapter 13

By Jonathan on July 20, 2006

I note a series of recent posts on the NACBA list serve about used car dealers who are using "starter lockouts" against Chapter 13 debtors to prevent the debtors from driving their cars. As I understand the technology, a starter lockout is a device installed in the electrical system of a car that can be activated by satellite.

In a non-bankruptcy situation, the starter lockout is a way for a used car dealer to disable a vehicle if the buyer misses a payment or bounces a check. In the cases discussed on this list serve, it appears that the lockout was activated prior to the bankruptcy filing and the car dealers are refusing to cancel the starter lockout despite the bankruptcy filing.

The consensus on the list serve is that a used car dealer who refuses to cancel a starter lockout is in violation of the automatic stay. The practical effect of the dealer's action is equivalent to a dealer who refuses to return a repossessed vehicle after a filing.

If you are a debtor or a debtor's lawyer who is dealing with a starter lockout, then you most likely have a cause of action for damages for the car dealer's violation of the automatic stay.

In the Nothern District of Georgia, where I practice I have always had success forcing a used car dealer to return a vehicle seized prior to the bankruptcy filing, although I usually do have to make a case that the debtor will be able to make the case work.

[tags] starter lockout, automatic stay, automatic stay violation, adversary proceeding [/tags]

Means Test Budget Serves as an Classification Tool, Not a Budget to Be Actually Used

By Jonathan on July 15, 2006

Having run through several means test calculations over the past few days, it struck me that a lot of the misunderstanding about both the median income test as well as the means test arises from a fundamental misunderstanding in the press and the general public about what the results of a means test really signifies.

The means test, as you may know, involves the creation of a "budget" in which expense categories are limited to acceptable expense figures that are based on IRS derived numbers. For example, under the current tables, IRS tables say that a family of 4 living in Fulton County may spend $1,529 for rent or a mortgage. If the actual mortgage for that family of 4 is $1,900, then for means test purposes $371 (the difference between $1,900 and $1,529) is "disposable" and available to use in a Chapter 13 payment.

If you actually file a Chapter 13, however, you can claim the full $1,900 as your mortgage expense on Schedule J of your budget. For Chapter 13 purposes, your budget must be reasonable and you are subject to the good faith requirements of the Kitchens case at its progeny.

The means test only serves to tell you (1) that Chapter 7 is or is not an option (2) if you have to file a Chapter 13, whether that Chapter 13 can be a 3 year plan or must it be a 5 year plan.

The "disposable income" bottom line of the means test has no correlation with a real life budget that you would actually file in your Chapter 13 case (or Chapter 7 case for that matter). In fact, I would suggest that there is almost no likelihood that your Schedule I & J budget will match your means test budget. I have actually been questioned about this by Chapter 7 trustees and my response has been to advise the trustee that the means test does not reflect a real budget and it was never intended to represent a real budget. There is nothing in the Code to suggest that IRS budget categories should be use on Schedules I & J.

The judges in the Northern District appear to be on board with this understanding. Both Judge Mullins and Judge Massey have ruled that the debtors' actual disposable income controls over the theoretical disposable income as determined by the means test. Presumably this means that a Chapter 13 debtor can qualify for a 3 year plan based on actual disposable income even if the means test budget shows sufficient disposable income to mandate a 5 year plan.

So, recognize the means test for what it is – a qualification tool, but nothing more.

[tags] means test, median income test, Judge James Massey, Judge C. Ray Mullins, means test in Georgia, means test 11th Circuit [/tags]

Financial Obligations to Ex-Spouse Set Out in Divorce Decree May Survive Bankruptcy

By Jonathan on July 14, 2006

The Georgia Supreme Court recently considered the issue of whether a debtor/ husband could be held in Contempt of Court in Superior Court for refusing to pay a joint marital debt. In the case of McGahee v. Rogers, the trial court denied the contempt motion on the grounds that (1) the debtor/husband had discharged his obligation to pay the debt and (2) because the debts had been discharged, contempt relief was inappropriate.

The Georgia Supreme Court reversed and remanded, holding that (1) the Bankruptcy Court had not specifically ruled on whether this joint debt was in the nature of alimony and support – and therefore non-dischargeable, and (2) that the Superior Court judge had "concurrent" jurisdiction to make this dischargeability determination. The Supreme Court then sent this case back to the Superior Court judge for a dischargeability determination.

What does this mean?

Firstly, it appears that the Georgia Supreme Court is going beyond the question of whether the debtor/husband is liable for contempt. If the Superior Court judge finds that the joint marital debt obligation is in the nature of support/alimony (Bankruptcy Code Section 523(a)(5) debt) then the debtor/husband will still be responsible to pay this debt [for the benefit of his wife] despite the bankruptcy discharge, and can be punished by contempt remedies, including jail, if he does not pay. If the Superior Court judge holds for the wife, it would appear that the husband's financial obligation under the divorce decree remains due and owing.

Second, it re-establishes that the Georgia Superior Court judge has the authority to make a ruling on whether a debt is dischargeable pursuant to the Bankruptcy Code.

Third, it is instructive to note that the applicable Bankruptcy Code used in this case was the pre-October 17, 2005 Code. The October 17 amendments changed both Section 523(a)(5) and (a)(15) to expand the exception to discharge for marital debts. Gone is the "balancing test" of former Code Section 523(a)(15). Under the current Code, it appears that just about every debt arising from a divorce is non-dischargeable. The practical impact of this will be to eliminate the strategy of using a bankruptcy filing to get rid of a divorce related debt.

Finally, as a matter of strategy, I am suggesting to my colleagues in the domestic relations bar that they should specifically include in every divorce settlement agreement a provision that clearly excepts marital debts from bankruptcy discharge. In turn, if the ex-spouse does file bankruptcy it should be very easy to get a quick (and inexpensive) ruling from the Bankruptcy Judge holding that the marital debt is non-dischargeable. Hopefully the net effect of cases like McGahee and the new Code provisions will reduce the need for costly litigation.

Along the same lines, it might make sense for divorcing parties to consider filing a joint bankruptcy prior to the divorce for the purpose of eliminating joint debt and potential problems.

Remember, even if you can hold your ex-spouse in contempt for failing to pay a joint debt, your rights against your ex-spouse have no effect whatsoever on the creditor. The creditor can sue you, garnish your wages and bank accounts – it becomes your problem to force your ex-spouse to make you whole again.

Thanks to Scott Riddle and his Georgia Bankruptcy Blog for highlighting this case.

[tags] divorce and bankruptcy, georgia bankruptcy, georgia divorce, 523(a)(5), 523(a)(15) debts in the nature of alimony and support [/tags]

Family Car Loans May Spell Trouble in Chapter 7 Cases

By Jonathan on July 13, 2006

Florida Attorney Jonathan Alper discusses in his Florida Bankruptcy blog several important considerations if you are thinking about turning to a family member to help you buy a car prior to filing bankruptcy. In a scenario I have seen on occasion, Jonathan describes meeting with a client who had asked his parents to help him buy a car. The parents bought the car, but titled it in the debtor (son's) name and never recorded a lien to secure their loan to the son.

In this situation, the "loan" from the parents is unsecured (no different than a credit card) and, worse, the son cannot include the monthly car payment as a secured debt for means test purposes. For bankruptcy purposes, therefore, this car is owned free and clear by the son/debtor and it counts as an asset.

The big picture point here, I think, is that if you are thinking about filing for bankruptcy, you should never take drastic action like buying or selling a car or house without first speaking to your lawyer. Even if those recent transactions can be reversed, they may still count against you in Bankruptcy Court.

[tags] family car loans, means test, pre-bankruptcy planning, Chapter 7, Georgia bankruptcy, Georgia Chapter 7 [/tags]