The greatest fear of many families in serious financial trouble is that they will lose their homes. Bankruptcy offers a last chance for families to save their homes by halting a foreclosure and by repaying any default on their mortgage loans over a period of years. Mortgage companies participate in bankruptcy by filing proofs of claim with the court for the amount of the mortgage debt. To retain their homes, bankruptcy debtors must pay these claims. This process is well established and, until now, has been uncontroversial. The assumption is that the protective elements of federal bankruptcy shield vulnerable homeowners from harm.
This Article examines the actual behavior of mortgage companies in consumer bankruptcy cases. Using original data from 1,700 recent Chapter 13 bankruptcy cases, I conclude that mortgage companies frequently do not comply with bankruptcy law. A majority of mortgage claims are missing one or more of the required pieces of documentation for a bankruptcy claim. Furthermore, fees and charges on claims often are poorly identified, making it impossible to verify if such fees are legally permissible or accurate. In nearly all cases, debtors and mortgage companies disagree on the amount of outstanding mortgage debt.
Despite these irregularities, mortgage claims in bankruptcy are contested infrequently. Imposing unambiguous legal rules does not ensure that a system will actually function to safeguard the rights of parties. The findings of this Article are a chilling reminder of the limits of formal law to protect consumers. The observation that laws can underperform has crucial implications for designing legal systems that function as intended and for evaluating the appropriate scope of consumer protections.
Misbehavior or mistake by mortgage servicers can have grave consequences. Undocumented or bloated claims jeopardize a family's ability to save its home. Beyond bankruptcy, poor or abusive mortgage servicing undermines the United States' home-ownership policies by exposing families to the risks of overpaying or suffering unjustified foreclosure. This Article's findings offer an empirical measure of the validity of concerns about whether consumers can trust mortgage companies to adhere to applicable laws.
Families in serious financial trouble are under great stress. The telephone rings with repeated calls from debt collectors, each paycheck is at risk of garnishment, and the next knock on the door could be a process server or a repo agent. Yet, for many families, the greatest fear is losing their homes to foreclosure. A home is not only most families' largest asset, but also a tangible marker of their financial aspirations and middle-class status. A threatened or pending foreclosure can signal the end of a family's ability to struggle against financial collapse and begin an unrecoverable tumble down the socioeconomic ladder.
Bankruptcy offers these families one last chance to save their homes.1 A bankruptcy filing halts a pending foreclosure and gives families the right under federal law to cure any defaults on mortgage loans over a period of years.2 The bankruptcy system offers refuge from the vagaries of state foreclosure law, substituting the protections of the federal court system and uniform legal rules to ensure that these families get one final opportunity to preserve their homes.
But this protection comes at a cost. Mortgage companies file proofs of claim with bankruptcy courts for the amount of mortgage debts. In turn, bankrupt debtors must pay these claims or lose their homes. The balance between the family and the mortgage lender is clearly spelled out in the bankruptcy laws, which specify the manner in which the amount owed is to be established and obligate both the homeowner and the mortgage company to disclose information accurately.3
This claims process is well established and, until now, has been uncontroversial. Homeowners-backed up by lawyers, policy makers, and news reporters-assume that bankruptcy functions according to the official rules and that it provides a realistic opportunity for families to save their homes if they follow those rules. …