Law Review: Pang, Belisa, Invisible Mortgages in Bankruptcy (June 05, 2024)

Available at:   https://ssrn.com/abstract=4939831

Abstract:

This paper identifies a previously unexplored channel through which bankruptcy affects consumer welfare: the presence of retained mortgages and their invisibility in post-bankruptcy credit reports. Using credit bureau data, this paper reveals that approximately 70% of mortgagors in Chapter 7 bankruptcy and 56% of those in Chapter 13 bankruptcy had mortgages in good standing when they first filed. Similarly, court records show that 74% of mortgagors in Chapter 7 bankruptcy intended to retain their mortgages, and only 7% of properties intended for retention were foreclosed within three years, compared to 69% of those intended for surrender. This demonstrates that, surprisingly, most homeowners who filed for bankruptcy nevertheless did not default on their mortgages. However, once the homeowners filed, nearly 79% of their mortgages disappeared from their credit reports or stopped being updated. In other words, the homeowners stopped getting credit for keeping their mortgages current; their mortgages became invisible. Using event studies, this paper shows that this mortgage invisibility harms these homeowners, leading to a 15 to 30-point reduction in their credit scores, a $1,500 decrease in their credit card limits, and a 1 percentage point increase in their auto loan interest rates. Therefore, this paper advocates for reporting practice changes to better reflect the financial realities of retained mortgages in bankruptcy.

Commentary:

This is a recurring problem for Chapter 7 debtors since by not reaffirming a secured debt, that creditor isn’t reporting their on-going payments to the credit bureaus, depriving them of those payments to help rebuild  their credit score. 

This is less of an  issue  with car loans, since those are more often reaffirmed and also because clients more easily grasp the risk of a repossession deficiency. 

It  continues,  however,  to be an issue with mortgages, since ride-through is still the preferred option and often the only one allowed by bankruptcy courts. 

The first thing when explaining this to a client is to make sure they understand the difference between the liability that the Deed of Trust creates against the house (i.e., if the mortgage isn’t paid the house will be sold at foreclosure) and the client’s personal liability (i.e., that they would owe any deficiency.) 

It is also important that paperwork clearly disclose the options regarding reaffirmation and ride-through, but that the bankruptcy judge generally won’t approve reaffirmations for real property. 

This is to counteract the invariable statement (which is likely the Unauthorized Practice of Law)  made by the mortgage servicers that "your lawyer screwed up" as the debtor should have  signed a reaffirmation. 

The reason that a mortgage company might not report on-going payments is both out of spite on their part, but also out of an over-abundance of caution. If, instead of making all of their post-discharge payments on time, the client had been delinquent, there is case law holding that reporting such delinquency to a credit bureau is a violation of a debtor’s discharge, since the debtor wasn’t personally delinquent. Since they can get burned for reporting bad information, mortgage companies often take the safe route and choose to not report any information. 

One of the key facts of the credit reporting laws is that creditors can only report accurate information. They are not, however, required to report any  information,  instead choosing  to remain silent. 

It is possible, nonetheless, for a client to still get their payment history included in their credit report., as follows: 

1. The client should request a payment history from the mortgage servicer. 
2. The client should then file a dispute with the three credit bureaus, attaching a copy of the payment history from the mortgage servicer. 
3. The credit bureaus are  required to verify the accuracy of the debt and dispute with the mortgage servicer within 30 days. 
4. At that point, the mortgage company can either: 

• Remain silent, in which case  the credit bureau must accept the nonfrivolous information provided by the client; 
• Accurately report information. 
• The mortgage company would be hard pressed to explain how a payment history it prepared was inaccurate. 

1. The client will need to repeat this process on a regular basis, to update the information. 
2. Additionally, the client should keep the payment history, since that can be provided to anyone they’re applying to for new credit. 

This process, while a headache for debtors, at least gives them a route to accomplish their goals, whether they follow through or not is a different question.  

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