Home rate hikes mean bankruptcies to spike

by Brad Carlson Idaho Business Review
07/24/2006

Idaho bankruptcy filings plunged in the second quarter of 2006 from the same period a year earlier.
The U.S. Bankruptcy Court in Boise received 732 case filings in the most recent quarter. A year ago 2,759 cases were filed.

Last year many people rushed to the courthouse to file for bankruptcy before major reforms took effect, a court official said. After the reforms were implemented, in October 2005, the number of new filings dropped across the country.

“It’s still the outgrowth of the Bankruptcy Reform Act,” Tom Murawski, court administrative analyst, said. “It’s probably going to be a while before it gets anywhere close to what ‘normal’ is.”

The new law requires people to complete a means test before filing for bankruptcy, resulting in fewer people qualifying for a Chapter 7 liquidation, Murawski said. The law also requires people to complete a financial management course and pay a higher filing fee.

It is having an effect. A court report shows 581 Chapter 7 liquidations from April through June, down from 2,425 a year earlier. Chapter 13 repayment plans also fell sharply, from 326 in the second quarter of last year to 142 this year.

The bankruptcy court in Boise received seven Chapter 11 reorganizations — mainly involving businesses — down from six in the second quarter of 2005, the report said. The court saw two Chapter 12 family farm cases in the second quarter of both years.

Bernie Rakozy, a Chapter 13 trustee in Boise, said the new law put an end to “Chapter 20” combinations that became common during last year’s filing frenzy.

In a Chapter 7 bankruptcy, a trustee sells assets to pay creditors and the filer is cleared of unsecured debt, assuming there are no objections during the hearing process.

In a Chapter 13, the filer completes a repayment plan under the court’s direction — usually on secured loans and tax debts.

Rakozy said it had been common for people to wipe out unsecured debt in a Chapter 7 within about 60 days of filing, then immediately file a Chapter 13 so they could make payments on secured loans and keep homes and cars. The new law requires someone to wait four years between completing a Chapter 7 and filing a Chapter 13.

Filers under either chapter can keep up to $100,000 in home equity. Limits vary by state, and Idaho raised its limit from $50,000 as of March 31.

Razozy said curing a mortgage default in a Chapter 13 is increasingly worthwhile, because the higher home equity exemption and recent big gains in home values mean borrowers have a chance to emerge from a bankruptcy with significant home equity.

However, the high home values represent a two-edged sword in the bankruptcy world, partly because they resulted from increased use of short-term, adjustable-rate mortgages, he said.

“In the next three to four months, you’re going to see an increase in Chapter 13 filings,” Rakozy said.

“A lot of these short-term mortgages are coming due” — at much higher interest rates — “and borrowers are not going to be able to come up with the money to refinance,” he said. “A lot of real estate is being sold with a first and second mortgage.”

Many two-income households lack sufficient reserve accounts to handle one person’s job loss if the economy softens, Rakozy said.

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To contact the author, send email to: brad.carlson@idahobusiness.net.