Housing downturn bankrupts borrowers
Sentinel Staff Writer
August 6, 2007
The housing boom may seem a distant memory, but experts say the real-estate speculation and “creative” financing it generated are now driving many investors and homeowners into bankruptcy, especially in Central Florida.
Personal bankruptcies in the Orlando area were up 80 percent during the first half of 2007 – the biggest rate increase in the federal court system’s Middle District of Florida, which includes Jacksonville and Tampa. Orlando’s jump in bankruptcies also far outstripped the national rate, which was up 43 percent compared with the first six months of 2006.
Orlando bankruptcy lawyer Richard Heller is seeing a lot of people these days who thought they had placed a sure bet during the recent housing boom.
Instead, their gamble on the housing market is sending many of them to the poorhouse.
“Some would buy land for, say, $750,000, then use all their 401(k) and other money to keep the mortgage paid,” Heller said. “At the end, the best they could get for it was $550,000 – and they’d still owe $750,000. They didn’t understand the risk they were taking.”
Though the number of personal bankruptcies is far below the pace set during the first half of 2005, when Americans flooded the court with filings to avoid a tough federal law that took effect that October, the pace is roughly back to what it was a decade ago.
And local bankruptcy lawyers say a growing number of those nearing insolvency are trapped by crushing mortgage debts.
They include vacation-home buyers, condo investors and other speculators who tried to time the market’s peak. But they also include homeowners who overreached by using “creative” mortgages with adjustable rates and low down payments to finance their purchases. As those rates have risen, some borrowers’ monthly payments have nearly doubled, even as their homes’ values have stagnated or fallen.
As a result, Heller and other bankruptcy lawyers say their day-to-day customer traffic now rivals the period before the 2005 reform law, which was designed to discourage personal-bankruptcy filings.
“In terms of consultations, we are back to the level of pre-reform days,” Heller said. “Has our actual caseload of filings reached that level? No, not yet. But I’m sure it eventually will.”
What’s happening in Central Florida is happening in Southern California and other areas of the country where speculation flourished during the real-estate boom, said Sam Gerdano, executive director of the American Bankruptcy Institute, a research group based near Washington.
Record bankruptcies in '05
Insolvency is clearly a growing problem across the country, Gerdano said, though the number of U.S. bankruptcy filings is unlikely to surpass the 2005 record of 1.78 million anytime soon.
“Yes, consumer bankruptcies are up substantially over where they were last year, but it will take a while yet to reach the 1 million level,” Gerdano said. “Still, the underlying conditions are pointing in that direction.” About $1 trillion worth of mortgage debt is expected to adjust upward to a higher interest rate this year – more than triple the amount that rose last year, according to First American Loan Performance, a San Francisco research firm. Mortgage woes have even replaced credit-card debt as the most prevalent cause of personal bankruptcy in recent years, some lawyers say.
Many of those with mortgage problems are trying to fend off bankruptcy by renegotiating their loan terms, downsizing their lifestyles, taking second jobs or and making other changes to save money, lawyers say.
“We’re not talking just about people who are hardly making ends meet,” said Raymond Rotella, a partner in the Orlando law firm Kosto & Rotella. “We’re talking about some people with a sizable net worth and income-earning potential who are facing a serious dilemma.”
Chapter 13 vs. Chapter 7
An increasing number of those who declare bankruptcy end up in a Chapter 13 filing, which enables them to continue making mortgage payments but forces them to restructure and repay some of their other debt. In the more common form of bankruptcy, Chapter 7, the person’s debts are forgiven, but most assets are forfeited.
The 2005 reform law passed by Congress and signed by President Bush was in part designed to reduce personal-bankruptcy filings and to force more of them into Chapter 13 debt repayment, rather than Chapter 7 liquidations, by establishing a “means test.”
As a result, Chapter 13 filings have surged the past two years and now comprise about 40 percent of all bankruptcies in the court’s Middle District of Florida – double their historic rate.
“People are trying desperately to avoid filing,” said Andrew Baron, a veteran consumer-bankruptcy lawyer in Orlando. “But for a lot of them, it’s going to be the only sensible way out. Too many have been tapping their home equity to pay other bills in the past. Now that avenue is blocked off.”
Bankruptcy is certainly a more expensive process these days than it was before the reforms, experts say, because of added paperwork and documentation required by the 2005 law. The typical legal fee has doubled to about $2,000, though some lawyers still charge less than that.
“Even a Chapter 13 is very costly for an individual,” said Cora Fulmore, a mortgage counselor and director of the city of Orlando’s “Don’t Borrow Trouble” financial-literacy program. “So if a person has the financial means to avoid filing, it would be better if they sought relief from their lender and negotiated new payment terms.”
Richard Burnett can be reached at firstname.lastname@example.org or 407-420-5256.