Tax exemptions
One frequently asked question about note investing is, "What effect does bankruptcy have on trust deeds and mortgages " If you are using the start-up formula of buying and reselling notes, you only own the note for a minute and are not concerned about the payor filing bankruptcy. If you are holding notes yourself, it is possible that sooner or later one of your payers may file bankruptcy.
There is a certain amount of "Notelore" (false information) regarding bankruptcy. You must know the truth. We will give you a "street sense" or practical analysis of bankruptcy here. If you need legal help, consult your attorney. The number one fact is that bankruptcy will not absolve secured obligations like mortgages and trust deeds. Let's look at three bankruptcy cases and their outcomes.
Case 1: John and Doris moved out of the city to a desert resort property. They were semi-retired. When they suffered health problems and were unable to work, they could not meet their medical, credit card and loan payments. They filed bankruptcy.
During the bankruptcy they continued to pay on their home loans, although they often fell behind. We never hired or needed an attorney and made no court appearances. The bankruptcy discharged their doctor bills and credit cards. Our loan remained unchanged. However, John and Doris still could not catch up the house payments and we were forced to foreclose. They said they understood completely and there were no hard feelings.
During the foreclosure they sold the house to a wealthy investor who immediately started paying us five times the normal monthly payment. John and Doris moved to an apartment they could afford in Las Vegas. When they moved out, they left the house spotless.
Our loan effectively was transformed from interest-only to full amortization and was paid off in full before the due date.
Case #2: Bruno and Shannon were hit by the aerospace layoff crunch. They had moved from a large house to a smaller home to cut expenses, and then could not afford the smaller home. In addition, they had an IRS tax lien on the new home.
Similarly to John and Doris, they filed bankruptcy in order to wipe out their unsecured debts. They kept in touch with us throughout the bankruptcy and continued paying their home loans.
We didn\'t need to hire an attorney in this case either. Eventually, we received a notice from the bankruptcy court that our note had been discharged, which simply means that we could not sue the payers personally on the note. We still could foreclose on the trust deed, however.
After the bankruptcy, things got worse for Bruno and Shannon and they called to say they could no longer pay their house payments. We filed foreclosure and got the house back in the auction. Bruno and Shannon still live there as tenants and have paid their rent every month since the auction. The IRS lien expired 120 days after the foreclosure auction.
Case #3: Joel and Laura presented a different situation. They never could seem to make their loan payments. We foreclosed five consecutive times and each time they begged, borrowed or stole the money to cure each foreclosure at the last minute. In the process, they put a third and a fourth trust deed on the property.
After the fifth foreclosure, Joel and Laura got a divorce and Laura got the house. She immediately went back into default and we filed foreclosure number six. At this point she had no way to pay and nothing to lose. Encouraged by a bankruptcy petition mill, she filed bankruptcy.
In the bankruptcy, Laura filed a payment plan. In spite of the fact that she had gone into foreclosure five times consecutively and had now defaulted the sixth time, she proposed to pay all payments as they came due and at the same time catch up the delinquent payments over a three year period !
We hired an attorney to get quick relief from the bankruptcy stay, but Laura, acting without an attorney (in proper) ran circles around the attorney! She arrived at the bankruptcy court in a police car two hours late (very dramatic.) Her story was that "she was on the way to the bank to get the money for her payment plan payments when her car broke down." The judge gave her an extra month postponement (Another month of free rent !).
Finally, when Laura predictably failed to make her first plan payment and failed to make any post bankruptcy loan payments, the judge threw the case out of court (dismissed the case) as being ridiculous.
It did us absolutely no good to hire an attorney in this situation. The case would have been dismissed at the same time and for the same reason anyway. An uneducated person acting "in proper" and coached by a bankruptcy petition mill was able to run circles around a smart, highly knowledgeable lawyer.
End of story, right Wrong! It took another month after the dismissal before we were allowed to go on with the foreclosure ! We had to get the dismissal order entered (the papers had to circulate from the trustee back to the court and get entered).
When we called the bankruptcy court to ascertain the status of the case, we were informed that we had to come in to the court in person to find out what was going on. The court for the Central District is inconveniently located in Santa Barbara ! How would you like to drive there from Los Angeles two or three times in a row
We circumvented the "come in and check with us" syndrome by using the automated PACER system. Although we could look up the case by computer on PACER and see that the bankruptcy was dismissed, we could not complete the foreclosure auction until the paperwork "circulated" and the dismissal order was formally entered.
The only way we finally got the paperwork moving was to call the bankruptcy court and demand to talk to a supervisor. Overall, this was the only person who cared. The trustee, the judge and the attorney were merely going through the motions. It reminds me of the joke about the Boy Scout who fell into the outhouse He couldn't swim, but he still went through all of the movements.
Remember that nobody cares about you like you do. You have to call the trustee, call the court, appear at hearings, appear in court and at least get your say. You have to call to see where the paperwork is and keep it moving, or else it sits there.
In all three cases we prevailed. The first two cases were what we call friendly bankruptcies. They were done with the intention of wiping out unsecured debts and with the intention of seeing that we got paid on the home loans. The property owners honestly wanted to keep their homes.
The third case is what we call a hostile bankruptcy. The property owner was solely trying to stall and live in the property rent free as long as possible. They were being coached on bankruptcy fraud by a dishonest bankruptcy petition mill.
Is bankruptcy a problem It depends. If you are dealing with huge apartment complexes where the payers are corporations and are rent skimming huge chunks of money, they have every reason to fight you with every trick in the book.
If you are dealing with honest Mom and Pop homeowners who mean to pay their bills and keep their homes, you probably have little or no problems whatsoever.
Here\'s some more notelore: If the property value has gone down, can the bankruptcy court reduce (cramdown) the amount of the debt you are owed
No! The US Supreme Court was asked to decide (Nobelman vs. American Savings) which of two seemingly contradictory portions of the bankruptcy code would take precedence : One allowing cramdowns and the other protecting a lender\'s contractual right to collect the full amount due.
Judge Clarence Thomas (of Anita Hill "fame") wrote for the US Supreme Court in June 1993. Basically he stated that it would be impossible to reduce the homeowner borrower\'s outstanding mortgage principal without modifying the lender\'s contractual rights. The net result is that cramdowns under Chapter 13 on a borrower\'s principal residence are eliminated.
A similar Supreme Court decision last year ruled out cramdowns on Chapter 7 bankruptcies. Cramdowns on Chapter 11 bankruptcies remain unresolved.
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