Bankruptcy trustees around the country are seeing positive results when they team Chapter 13 repayment plans with debtor education. One result is a decrease in the number of repeat fillers.
BANKRUPTCY-RELATED LOSSES REMAIN ONE OF THE KEY FACTORS BEHIND DETERIORATING PROFITABILITY IN THE CREDIT CARD INDUSTRY AND ALSO REPRESENT A SIGNIFICANT LOSS TO MORTGAGE LENDERS' BOTTOM LINE.
As a result, industry literature has given increasing attention to loss mitigation in general and to bankruptcy-related loss in particular. How can a mortgage lender prevent, or at the very least mitigate, losses that result from financial failure that occurs in a borrower's life after a mortgage closes? Much has been written, during the past year especially, about several loss-mitigation approaches.
Earlier articles in Mortgage Banking have shown how Visa U.S.A. has focused on understanding the causes, implications and early indicators of bankruptcy.
Recognizing that more than 1.4 million households file for bankruptcy each year, Visa has dedicated resources to mitigating losses, both in terms of lost dollars and in terms of lost market potential once bankruptcy has been filed. This article reports on more than a year's work within the bankruptcy community that was undertaken to identify opportunities for loss mitigation and borrower rehabilitation.
A sleeping dragon for mortgage lenders?
Visa's research into the causes and implications of bankruptcy indicates that one or more of several specific triggers appear to function as the proverbial "last straw" in a decision to file bankruptcy. They include: 1) an unexpected external life crisis - lost job, catastrophic event, divorce and/or some combination of these, which makes it impossible to maintain the current debt load and/or reduces income; 2) an aggressive collections staff in one or more of the creditors' shops is perceived as harassing the borrower to desperation or refuses to work out a viable alternative repayment plan; and/or 3) the debtor acts on a premeditated plan to walk away from debt.
How can creditors distinguish as early as possible those consumers that are willing and able to repay some or all of their debt so that a work-out plan can be efficiently arranged? And how can they identify those debtors ultimately unable or unwilling to repay, in order to more quickly and efficiently resolve those cases and minimize losses? Various bankruptcy predictive models use increasingly sophisticated and accurate scoring methods to identify consumers whose spending behavior threatens to spiral out of control. However, those who ultimately declare bankruptcy appear to be giving less and less warning of their impending financial meltdown through current "red flag" systems.
Andrew Jaske provides a comprehensive analysis of current methods for "Managing Mortgage Credit Risk" in the May 1997 issue of Mortgage Banking. He describes the important role of prediction in prevention and examines the effectiveness of various tools for use during different stages of a product's life cycle - comparing and contrasting the life cycles of credit cards and mortgages. Jaske focuses on using scoring models not only to identify future likelihood of default, but to target collection resources.
Thomas Healy, in "The New Science of Borrower Behavior," in the February 1998 issue of this magazine identifies an expanded role for technology in recognizing that managing the mortgage servicing business also must rely on behavioral science "rather than purely physical science (i.e., mathematics)." Healy says that "increasing reliance on behavioral information allows mortgage servicers to better predict borrower behavior and, thus, better manage strategic performance." Healy adds, "Because much of the data required to understand borrower behavior is external to their firms, executives have insufficient knowledge that is economically attainable (especially for smaller players), readily available, consistent and actionable."
While behavior scoring is extremely helpful in identifying changes in spending patterns then, this tool is less likely to spot those external events that often in combination with other risk and economic factors propel a borrower into a bankruptcy attorney's office. This article focuses on what happens next.
Your borrower files bankruptcy: What now?
I spent the past 18 months in Chapter 13 Trustees' offices throughout the country with trustees and their staff, in interviews with both Chapter 7 and Chapter 13 debtors and observing Section 341 meetings (the "Meeting of Creditors") and in education and counseling classes as a participant. As a "dedicated resource" to the National Association of Chapter Thirteen Trustees, my assignment was to identify methods, tools and resources that will help increase the completion rate of Chapter 13 repayment plans filed by debtors and thus boost recoveries to lenders.
This article summarizes my observations and focuses on how Chapter 13 can provide financial management resources to debtors that will restore them to financial health. What I report are the short- and long-term successes that can be achieved when a mortgage lender cooperates with a Chapter 13 Trustee to work toward shared objectives and rewards - in short - the role of Chapter 13 bankruptcy in mitigating loss for lenders - both secured and unsecured.
What is Chapter 13?
Chapter 13 of the Bankruptcy Code is the alternative to Chapter 7 liquidation. As opposed to Chapter 7's provisions for repaying lenders from the proceeds of sale of a debtor's nonexempt assets at the time of filing, Chapter 13 looks to the debtor's future income as a source of repayment. When a debtor files a Chapter 13 case, he or she proposes a plan that commits all or a portion of available income for payment of money owed on mortgages and unsecured loans, priority debt (usually taxes) and general unsecured debts. To encourage Chapter 13 plans, the Bankruptcy Code gives debtors certain advantages, including:
* The ability to cure home mortgage arrearages.
* The ability to pay income taxes (interest and penalty free) over a period of up to 60 months.
* The ability to retain assets such as cars and furniture by paying their value, plus interest, over a period of up to 60 months.
* A "super" discharge, allowing discharge on successful completion of a Chapter 13 repayment plan of certain debts that would not be discharged in a Chapter 7 plan. (This might include taxes provided for by the plan, fraud claims and claims for intentional injury to person or property.)
A Chapter 13 debtor makes payments under an approved repayment plan to a Chapter 13 Trustee - a private party appointed and supervised by the United States Trustee - a Department of Justice official appointed to oversee the bankruptcy process. In addition, proposed Chapter 13 plans are submitted to a bankruptcy judge for approval, and the judge rules on disputes that arise among parties in a Chapter 13 case.
Congress intended that bankruptcy be a safety net, a last resort for consumers to use when they find themselves in an untenable financial position, either because of life events beyond their control or because they have seriously mismanaged their finances.
Since October 1, 1979, many trustees, creditors and debtor attorneys have realized that the so-called incentives in the code to encourage consumer debtors to file Chapter 13 vs. Chapter 7 do not necessarily result in 100 percent, or "high-pay," Chapter 13 plans. Generally, a debtor's proposed repayment plan is considered to be a high-pay plan if at least 85 percent of amounts owed to creditors are pledged to be repaid over a three- to five-year period.
To address this issue, ad hoc creditor groups, working with interested Chapter 13 Trustees and debtor bars, have developed programs that offer to Chapter 13 debtors the opportunity to obtain new credit in reasonable amounts for reasonable purposes. To access the new credit these debtors must have completed high-pay Chapter 13 plans and have completed a program providing basic financial education. These...