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Please, Judge, Save My House

When Randy Wood purchased his new four-bedroom house on this one-time floodplain in Plumas Lake, Calif., three years ago, developers told him that new levees should protect the subdivision from being underwater.

Unfortunately, they weren’t referring to a cascade of plummeting property values.

Today, after the California housing market has been inundated by the collapse of home values, Wood’s dream home is deeply underwater—even as California suffers through a worrisome drought. Like the vast majority of his 2,700 neighbors in this new subdivision, Wood figures he owes the bank about $100,000 more than his property is now actually worth.

“We’ve gone from being underwater to being underwater,” said Wood, 60, who has been forced to stop working after becoming disabled. He was told his living room would have been 12 feet underwater during the famous New Year’s flood of 1997. “We’ll never see a return on our investment. We were hoping to make a little profit to help our retirement … but now we have to look at it as if we’re paying an enormous rent.”

Owning this Spanish-style home with its large backyard had always represented the American dream to Wood, a longtime renter. Now, he said with some bitterness as he tended to his colorful flower bed, “it feels as if some big lie was told somewhere along the line. I guess we should have had more sense.”

Record holder for underwater homes

Welcome to the epicenter of the American housing crisis. In no county in America are more mortgages “upside down” than in Yuba County, about 35 miles north of the state capital, Sacramento, in California’s Central Valley. According to SMR Research, a New Jersey-based consumer lending research firm, 60.3 percent of all borrowers in this county owe more than their property is worth.

Across the nation, some 22.5 percent of mortgage holders—one out of every five borrowers—owe more on their homes to the bank than the property is now worth, according to Stuart Feldstein, SMR’s president.

“I’m sure there are a lot of very unhappy people in the county,” Feldstein said in a telephone interview. “There are likely to be more foreclosures in that county than in others, and it’s likely to be the epicenter of personal disappointment,” since, for most Americans, homes tend to be the principal retirement investment, ahead of stocks and bonds. And the crisis is worse for older Americans, who have less time to recover from their economic misfortune.

Marina Bolshakoff, 64, a legal assistant, hoped she could retire later this year. Now, unless she can reduce payments on the house for which she and her husband paid $410,000, she doesn’t see how she can quit.

“It makes you kind of sick, what’s happening,” Bolshakoff said. “Of course, I lost money in my 401(k) retirement plan, and now we have no equity in our home. I’m at a loss as to what to do … I don’t want to be working until I’m 90 years old.”

If you are among the record number of struggling families who face escalating mortgage payments on a home where much of the value has already vanished, you may be running out of options. Most banks are not keen to renegotiate rates or extend loans, opting instead to foreclose on properties.

Nor, as thousands of Americans are now learning, is there any help to be found in bankruptcy codes written a generation ago and not updated effectively, despite today’s era of exotic home loans and steep, sudden drops in property values.

President-elect Barack Obama and congressional leaders agree on the importance of revamping these codes, especially the 1978 provision that specifically prevents a judge from modifying the loan on your home even though he can change provisions on other kinds of debt.

“A judge can reduce the value of a sailboat or a vacation home … but not the primary residence,” said Robert Lawless, a bankruptcy expert who teaches at the University of Illinois Law School in Urbana. “I think it’s completely perverse, but no one was paying attention back when that law was drafted.”

“I thought if I filed for bankruptcy, it might force the mortgage company to work with me,” said Aleta Seifert, 51, of Cheboygan, Mich., a caseworker for the Salvation Army who fell behind on payments on the house she’d been living in for more than a decade.

It didn’t turn out the way she hoped. Seifert’s bankruptcy filing will allow her to restructure, and pay back over time, some $10,000 in consumer debt she had accumulated. But it didn’t keep the bank from foreclosing on her home. “I’m devastated,” she said. “I’ve never had to move before.”

Seifert is not alone. In the first three quarters of 2008, foreclosure filings topped 2 million, according to Realty-Trac, which publishes a national database of foreclosure and bank-owned properties. The 765,558 filings in the third quarter alone marked a 70 percent increase over the same period the year before.

Already, one of the nation’s major credit bureaus is forecasting that the number of consumers with delinquent mortgages may double by the end of 2009, hitting its highest level in at least 16 years. TransUnion, which analyzed about 27 million consumer records, predicts that the proportion of homeowners with mortgages that are two months or more past due will hit 7.17 percent at the end of 2009.

Advocates for legislative reform say that allowing a neutral arbiter, like a judge, to establish a home’s fair value or to reduce the interest rate of a mortgage could help reset property values for millions of troubled homeowners. Banks would lose some income as a result, they argue, but less than they would bear in a foreclosure proceeding.

“There’s no point in filing for bankruptcy if it doesn’t get you anywhere,” said Jay Westbrook, a bankruptcy expert who teaches at the University of Texas Law School in Austin. “The bankruptcy laws are exacerbating the foreclosure problem.”

A proposal to amend the lawsto give more leeway to home­owners never reached a floor vote during the last session of Congress because of fierce opposition from the banking and financial industries. But advocates believe that chances are much better in the new session, which begins in January, when Democrats will wield more votes in both chambers while also holding the keys to the White House. During the recent election campaign, Obama proposed modifying bankruptcy laws to give more assistance to homeowners in distress. He also recommended a 90-day moratorium on foreclosures.

“We think the prospects are good [that a reform bill can pass early in the next session]. The fact that the new president and the new administration look favorably on bankruptcy reform should help quite a lot,” said Joe Shoemaker, a spokesman for Sen. Dick Durbin, D-Ill., who has sought to reconfigure the bankruptcy code to permit mortgages on a primary residence to be modified. Some on Capitol Hill think the provision could be tacked onto the economic stimulus package the new administration will press Congress to enact.

The president-elect has endorsed reintroducing so-called cram-down legislation, which allows judges to force banks to accept less money on a mortgage in default. Paul Leonard, California director of the nonprofit Center for Responsible Lending, based in Durham, N.C., said that such a change would give borrowers like Seifert “new leverage” in trying to restructure a loan with their banks ahead of foreclosure. “If a borrower now has the option to go to a bankruptcy judge who can modify his home loan … then the borrower has more power” to negotiate with his lender, he noted.

That kind of change causes queasiness among the nation’s bankers. Giving judges the ability to modify the mortgage on a primary residence would “impose added risk and uncertainty to lenders and increase costs for the majority of consumers,” said Peter Garuccio, a spokesman for the American Bankers Association. The industry argues that such a change could increase the long-term cost of credit and unduly reduce the number of those eligible to receive loans.

During the long real estate boom, eligibility for a home loan rarely seemed to pose much of a problem, even for people with questionable resources. So-called liar loans, where applicants merely had to state their income without providing proof, became commonplace in many cities from Florida to California.

Today, however, in neighborhoods all across the country, millions who bought their houses with little money down or with a low “teaser” rate and an adjustable-rate mortgage (ARM) now find themselves swamped as their monthly payments rise dramatically.

Jed Davis, chief executive officer of Neighborhood Partnership Housing Services in Ontario, Calif., a nonprofit operating in a region hit hard by the national foreclosure crisis, said he sees many people living in $300,000 homes who used to pay less than $1,000 a month on their mortgage. Today, they’re paying $3,000 a month as their rates adjust, yet the houses may be worth only $220,000. Because many homeowners have no equity in their home, “there’s a great temptation to just walk away,” Davis said.

Supporters of bankruptcy reform say that if a house were treated like any other asset, a judge could determine its market value and order a bank to rewrite the mortgage to reflect that value, or lengthen the term of the loan in order to cut the monthly bite. A 1993 decision by the U.S. Supreme Court, however, reaffirmed that a judge cannot tamper with an existing loan on a debtor’s primary residence.

The result of that ruling is that an investor with five houses “has a right to restructure” the terms by which he pays off his debts, said Ike Shulman, of San Jose, Calif., a former president of the National Association of Consumer Bankruptcy Attorneys. “The only house you can’t restructure is the one you and your kids live in.”

 Experts say that when the 1978 law passed, almost all home loans were conventional, 30-year mort­gages with fixed interest rates. Prices were stable and didn’t wildly rise or fall in value. Constant refinancing was also rare. At the time, the banking industry demanded some financial protection as Congress sought to encourage banks to make loans so that thousands could gain “the American dream” and own their own homes. Under that law, most consumers could seek debt relief by filing Chapter 7 bankruptcy, which wiped out most obligations not secured by property, such as credit card debt and medical bills.

Nearly 30 years later, in 2005, the law was revised. Credit card issuers and financial institutions lobbied successfully for revisions that made the protections more restrictive. Now, most people in debt are compelled to file for bankruptcy under a less accommodating Chapter 13, which usually gives them more time to repay their bills but does not eliminate existing debt. But bankruptcy judges still are not permitted to change a mortgage contract, which means they cannot reduce a monthly payment or an interest rate. So when Juliet Stewart, 46, of Oakland, Calif., and her husband, James, filed for Chapter 13 in December, they were able to restructure their other debts—but not their $3,700 mortgage. “You still have to make those payments,” said Stewart, who is considering a second job.

As the nation’s pace of foreclosures in­creases, whole neighborhoods feel the pain, which is one reason why many are pushing to help those in trouble. After all, when home prices drop, the local tax base, which funds state and local government, also erodes. And in a town full of foreclosures, residents hoping to cash out of a home as they prepare for retirement realize they can no longer afford to move.

The surge in foreclosures is also undermining the very banks that advocated tougher bankruptcy laws—they’re weighted down by foreclosed properties and bad loans on which they’ll never collect. “We all recognize that the only way to ever get close to stopping the bleeding of the banks is to put a floor on the prices of houses,” said bankruptcy attorney Shulman.

Yet without some means to force banks to modify loans, property values will continue to decline, warned Shulman. “Foreclosures drive prices down, which is bad for everyone, not just for those in the house but also for those living next door.”

Michael Zielenziger, a visiting scholar at the University of California-Berkeley, writes about business, economics and Asia.

 

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