How to Keep Your Home and Avoid Bankruptcy Pitfalls

Bankruptcy is supposed to offer families who have fallen behind on their bills one last chance to save their homes from foreclosure. Filing a petition under Chapter 13 of the Bankruptcy Code allows them to reorganize their debt that is past due and repay creditors over a period of three to five years.

Unfortunately, many homeowners that take this route make all the payments under their plan, only to be hit with hundreds or thousands of dollars in additional fees once they emerge from bankruptcy. Unable to meet this additional and unforeseen burden, some find themselves facing foreclosure right after bankruptcy or needing to file for bankruptcy again.

That's what Katherine Porter, an associate professor at the University of Iowa College of Law, found in a study of 1700 bankruptcy cases filed in 2006. She told a U.S. Senate panel earlier this month that banks "routinely disobey bankruptcy law and attempt to collect thousands more dollars than consumers believe is owed."

How does this happen?

It comes down to the role of mortgage servicers, the companies that collect payments from homeowners and take action if they default on their loans. Servicers have come under fire during the housing crisis for failing to modify mortgage loans when borrowers run into trouble. Porter says servicing is even less reliable in bankruptcy.

Here are some common examples of abusive practices Porter uncovered in her study:

• Failing to document the purported debt or to attach the required documentation to claims
• Filing motions for relief from the bankruptcy stay to proceed with foreclosure when the debtor is actually current on payments
• Misapplying payments received during the bankruptcy case. For example, some servicers apply funds intended to pay off past-due debt to new charges, so the borrower doesn't reduce the arrearage. In other cases, servicers apply funds intended for current payments to past-due debt, so that the borrower appears to be in default on the current month's payment.
• Double-counting escrow amounts, funds set aside each month to pay taxes or insurance on the property, by including them in both the arrearage amount and in the calculation of the amount of ongoing payments
• Violating bankruptcy rules regarding the disclosure of attorney's fees
• Imposing default-related charges, such as the cost of an appraisal, during bankruptcy even when there is a bankruptcy plan to cure the arrearages or continuing to impose such charges even after the debtor has cured the default.
• Failing to disclose post-bankruptcy fees or costs to debtors, trustees or bankruptcy courts
• Disregarding the escrow calculation and disclosure requirement of the Real Estate Settlement Procedures Act during the bankruptcy case
• Attempting to foreclose after a debtor receives a bankruptcy discharge despite the debtor properly making all payments during the bankruptcy plan

Just how common are these practices? Porter says that in slightly more than half of the cases she examined (52.77%), servicers filing proof of their claim in bankruptcy court failed to provide the required documentation. And in just over a third of the cases (34.33%), the claims included fees that weren't easily identifiable or lumped a number of charges together in a single figure.