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socrateaser, Attorney
Category: Bankruptcy Law
Satisfied Customers: 39048
Experience:  Attorney and Real Estate Broker -- Retired (mostly)
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I am considering a chapter 7 bankruptcy and exempting my home.

Customer Question

I am considering a chapter 7 bankruptcy and exempting my home. I had a second mortgage of $280k that the bank (BofA) has "charged off" and sent to collection. This seems odd to me...why not start forclosure? The question is how the court would handle that debt in a chapter 7. Would it be discharged?
Submitted: 8 years ago.
Category: Bankruptcy Law
Expert:  socrateaser replied 8 years ago.

What you're describing "is" interesting. I doubt that anyone actually knows the real answer yet.


Banks have the following problem. Rreal Property has fallen in value such that the mortgages are worth more than the property to which the mortgages are secured.


If a bank forecloses, it must "mark-to-market" all similar assets in its portfolio. So, if a bank has 20 home loans in a neighborhood and all of them are $200,000 "underwater," then foreclosing on any one of them costs the bank $4,000,000. So, the banks are now choosing to not foreclose, allow the homeowner/borrower to remain in the property "rent-free," and thereby maintain the bank's asset valuation.


If you're a homeowner who put no money down to purchase a home, this is a pretty sweet deal. If you're a prospective buyer, this is a horrible deal, because you can't buy real estate with any security that you're actually paying fair market value for your purchase.


Anyway, I am speculating that your lender has decided to try to collect against you personally, because New York has no "anti-deficiency" law which prevents the lender from getting more than just the underlying property via foreclosure. Which means that the lender can keep its asset value, not have any legal responsibility for maintaining the property (because the bank would be the owner if it forecloses), AND the bank can go after the owner for any other assets that the onwer may have to satisfy the loan.


And, if the bank has a trust deed on the property, it can STILL foreclose later if it wants, even though it has sold the promissory note to a collection agency.


All that said, secured debts, such as trust deeds are generally not dischargable in bankruptcy. But, here, the question becomes: by sellijng the note and severing it from the underlying security, does the lender convert its secured debt into an unsecured debt, which is dischargable in bankruptcy?


I think the answer is "yes," but I don't really know, and I don't think that there's any case law on the issue yet, because this is a brand-new game being played out in the new economy.


I will check around and see if anyone else has a brilliant thought on the subject. If I find it, I will try to post it to this thread. But, otherwise, you will have to get a consult with a local bankruptcy attorney and see what he/she thinks. I have a hunch it will be "I dunno, but let's file and see what happens."


Bankruptcy lawyers give free consultations, generally, so you hav nothing to lose other than an hour of your time.



socrateaser and other Bankruptcy Law Specialists are ready to help you
Expert:  socrateaser replied 8 years ago.

I believe that this case is relevant, although it refers to Chapter 13, rather than 7 bankruptcies: In re Zimmer, 313 F.3d 1220 (9th Cir. 12/24/2002). The gist of it is that a debtor may discharge a seured 2nd mortgage on his/her primary residence where the 1st mortgage is worth more than the underlying residence.


That is, because if the property is worth so little so as to make the 2nd loan effectively unsecured, then that loan will be treated as unsecured in fact, regardless of whether or not it was originally secured by the property.


It would be one thing for "you" to try to severe the lender's promissory note from the trust deed on your property. But, if the lender does it by selling the note, then the debt is unsecured and subject to discharge.


What I still don't know is whether the bare trust deed note could be foreclosed on, even though there is no promissory note. Some trust deeds may have language describing the value of their secured interest apart from the note. So, it may be possible to foreclose anyway. But, here again, we're into uncharted waters, I believe.


In any event, if you ever come up with a complete answer, please come back and you can be the expert and I'll be the customer!