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How to Keep Your Home and Avoid Bankruptcy Pitfalls

These traps can worsen your financial situation even if you clear bankruptcy.

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."

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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.

Sen. Charles Schumer (D., N.Y.) has reportedly has asked the Federal Trade Commission to investigate

Countrywide Financial

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, the nation's largest mortgage lender and a leading servicer, for alleged mistreatment of homeowners in bankruptcy. But Porter says, "I don't think Countrywide is worse than anyone else in the industry."

(Steve Bailey, who heads loan administration at Countrywide, told the same Senate panel that his company is taking steps to improve its servicing of loans to borrowers who are in bankruptcy. He also said an internal review of Countrywide's servicing of bankrupt borrowers' loans found "errors adversely impacting borrowers are at a rate of less than 1%.")

So what can you do to hang on to your home if you get behind on your payments?

Get It In Writing

Whether you're in bankruptcy or not, never take it for granted that a mortgage company is properly crediting your payments, particularly if you're making a late payment -- or for that matter, any kind of unusual payment, such as paying down the principal. "Across the board, this is a high volume, low-staffed industry, and it's not designed to deal with unusual circumstances," Porter says in an interview.

She notes consumers have the right under Real Estate Settlement Procedures Act to make what is called a 'qualified written request.' This is a written letter -- not email -- sent to the mortgage servicer that says 'I think there could be a mistake and I want more information,' and requesting a payment history or payoff statement. The servicer has 20 days to acknowledge that it got the letter and 60 days to provide the information.

It's often difficult to find out where you need to send the request, but Porter says most courts say the address on your payment coupon is good enough.

If you don't agree with the servicer's statement, the first thing to do is call the servicer to dispute it. But it can also be difficult to find a phone number. If you are already in foreclosure, you should contact either the court, the foreclosure trustee, or whoever is handling the sale of the house, and tell them about the dispute. (Foreclosure procedures vary from state to state.)

If you're in bankruptcy, you should either contact your bankruptcy attorney or the bankruptcy trustee.

Make Sure You're Really Caught Up

If you're behind on payments and trying to figure out how to catch up, don't assume that all you owe is the missed payments -- late charges, deferred interest and other kinds fees such as appraisals can pile up quickly. (If lenders think they might have to foreclose, they want to know exactly how much your property is worth in the current market.) If you just send in the missed payments, and it's not the full amount you owe, your check might be sent back or the funds placed in a "suspense account." In theory, Porter says, the lender will eventually credit that money, but in the meantime you still aren't current and the penalties and fees continue to pile up.

Part of the problem is that borrowers are writing two separate checks each month, one for their current mortgage payment and another that goes toward the arrearage. This multiplies the opportunities for services to miscredit payments. If servicers do make mistakes, they can be hard to catch because the person or party paying the bill may not be getting the mortgage statement. Porter says that in some jurisdictions, only the bankruptcy trustee gets a statement and in others just the debtor.