The National Mortgage Settlement and Lien Strip Poker

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Bankruptcy expert Leon Bayer answers real-life questions.

Dear Leon, 

I am in Chapter 13 bankruptcy with a confirmed plan, and I did a lien strip to remove my second mortgage (it is a second deed of trust with Bank of America). I just got a letter from BofA saying they are forgiving my second mortgage, they will send documents showing the loan is forgiven, and there is more nothing I need to do. My bankruptcy lawyer says that I’m not supposed to get the lien strip until I complete my five year Chapter 13 plan and get a discharge, and that therefore I must finish my Chapter 13 case in order to gain the benefit of the lien strip.  Is the bank writing this off now rather than waiting the five years? 

I just want to get a second opinion because it’s confusing.  

Thanks, 

Molly

Why BofA Forgave Your Loan

Good Golly Miss Molly!

You’ve lucked out. And I get to answer a fun question.

Of course, I have not seen the actual letter you received. However, it sounds exactly like letters many of my own clients have received. If it is, your second mortgage lender has indeed decided to give up now, instead of waiting the five years. Assuming I’m right, I’ll explain why this happened. I’ll also explain where it puts you. (But you should still take all the paperwork to a lawyer who is familiar with this.)

The National Mortgage Settlement: Banks Must Pay Owe $10 Billion for Mortgage Reduction

The Bank of America, along with Ally, Wells Fargo and several other banks are parties to the National Mortgage Settlement (NMS), a legal settlement requiring them to forgive a certain amount of home mortgage debt, including second mortgages. The settlement allows the banks to decide which loans to forgive, but the loans must total $10 billion. (You can learn more about the NMS at http://nationalmortgagesettlement.com/.)

Think about this settlement as if it were a debt that the banks owe to the public. They pay the debt by forgiving loans totaling $10 billion. After they do that, the debt is paid. Sounds like a good deal for consumers, doesn’t it?

Did Government Lawyers Get a Good Deal for Homeowners?

In agreeing to this settlement, the banks (but maybe not the government) realized that they could get full credit towards paying the $10 billion they owed by forgiving loans that were uncollectable anyway. Think about your loan. You’re not making payments on your loan. Throughyour bankruptcy, you are on track to discharge your personal liability for the loan. And your loan is already subject to a lien strip order. From the bank’s point of view, their chances of collecting money on your loan are slim to none.

Forgiving an uncollectable loan, just like yours is, makes good sense for the banks. It is similar to you giving a bag of old clothes to charity and getting a tax deduction for worthless stuff you were about to put in the trash.

If You Were a Bank, Which Loans Would You Forgive?

You would certainly keep loans that customers pay on time. That improves your balance sheet and keeps the bank healthy.

Because you must forgive some loans, you would probably choose loans that are in default. Even better, you would look for defaulted loans that are already involved in bankruptcy with a lien strip.

Small wonder why the bank picked your loan to forgive. For them, using your loan to pay off a bet was like drawing four aces in poker. Forgiving your loan (and the loans of others) makes the public think they are swell guys, but in your case (and many others), it doesn’t really cost them anything. They weren’t going to get paid on that bag of old loans anyway. But forgiving uncollectable loans pays off the settlement.

All in all, your bank is likely very happy with this deal. It gets to pay the settlement with a big bag of trash, instead of paying with real money. It also gets a tax deduction, just like you do for donating a bag of old clothes.

Here’s Where This Leaves You

Do you still need your Chapter 13 bankruptcy?  If the only reason you filed for Chapter 13 bankruptcy was to strip off your second mortgage, then perhaps you can dismiss the case and get out of bankruptcy right now. (But don’t do that until the lender records a full reconveyance of the deed of trust and a bankruptcy lawyer gives you the OK to dismiss.)

If you still have other debts to discharge, you may be able to convert your Chapter 13 to a Chapter 7 case.

A good reason to stay in your Chapter 13 is to cure arrearages that you might owe on your first mortgage. The forgiveness of your second mortgage does not alter what you owe on your first mortgage. Your Chapter 13 bankruptcy might also be managing debts that are nondischargeable, like taxes.

A knowledgeable bankruptcy expert can guide you on making the best choices.

– Leon

Leon Bayer is a Los Angeles bankruptcy attorney.  He is a partner at Bayer, Wishman & Leotta, a California law firm specializing in bankruptcy.  The opinions and advice in this blog post are from Mr. Bayer alone, and should not be attributed to Nolo.  By answering a question on this blog, Mr. Bayer does not become your lawyer.

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