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Misbehavior and Mistake in Bankruptcy Mortgage Claims

Misbehavior and Mistake in Bankruptcy Mortgage Claims

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Misbehavior and Mistake in Bankruptcy Mortgage Claims
Katherine Porter
*
 Abstract
The greatest fear of many families in serious financial trouble is that theywill lose their homes. Bankruptcy offers a last chance for families save their houses by halting a foreclosure and by repaying any default on their mortgageloans over a period of years. Mortgage companies participate in bankruptcy by filing proofs of claims with the court for the amount of the mortgage debt. In turn,bankruptcy debtors pay these claims to retain their homes. This process is well-established and, until now, uncontroversial. The assumption is that the protectiveelements of the federal bankruptcy shield vulnerable homeowners from harm.This Article examines the actual behavior of mortgage companies inconsumer bankruptcy cases. Using original data from 1700 recent Chapter 13bankruptcy cases, I conclude that mortgage servicers frequently do not complywith bankruptcy law. A majority of mortgage claims are missing one or more of the required pieces of documentation for a bankruptcy claims. Fees and chargeson claims often are poorly identified and do not appear to be reasonable. Thebankruptcy data reinforce concerns about the overall reliability of the mortgageservice industry to charge homeowners only the correct and legal amount of thedebt and to comply with applicable consumer protection laws. Mistakes or misbehavior by mortgage servicers can have grave consequences. Bloated claimscan jeopardize a family’s ability to save their home in bankruptcy. On a systemlevel, mistakes or misbehavior by mortgage servicers undermine America’shomeownership policies for all families trying to buy a home.The data also reinforce concerns about whether consumers can trust  financial institutions to adhere to applicable laws. The findings are a chillingreminder of the limits of formal law to protect consumers. Imposing unambiguouslegal rules does not ensure that a system will actually function to safeguard therights of parties. Observing the reality that laws can underperform or evenmisfire has crucial implications for designing legal systems that produceacceptable and just behavior.
*
Associate Professor of Law, University of Iowa. I thank the National Conference of Bankruptcy Judges’Endowment of Education for funding this research, Tara Twomey for her participation as co-investigator indeveloping the Mortgage Study database, and Ann Casey for invaluable empirical assistance at every point in thisproject. John Eggum, Sarah Hartig, Chris Jerry, Gina Lavarda, Brian Locke, and Nece McDaniel provided researchassistance. This paper benefited from the feedback of participants at the Harvard-University of Texas JointConference on Empirical Law Realities and from the comments of Robert Lawless, Lynn LoPucki, Ronald Mann,and Elizabeth Warren.
 
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 Misbehavior and Mistake in Bankruptcy Mortgage Claims
 .Table of ContentsINTRODUCTION .......................................................................................................................... 3I. STATEMENT OF PROBLEM ................................................................................................... 4A. The Structure and Function of Mortgage Servicing ........................................................... 5B. Mortgage Servicing in Bankruptcy Cases ........................................................................... 8C. Bankruptcy Litigation of Mortgage Claims ...................................................................... 11II. METHODOLOGY ................................................................................................................... 15III. FINDINGS .............................................................................................................................. 18A. Required Documentation for Mortgage Claims ................................................................ 18B. Default Fees in Mortgage Claims ..................................................................................... 24C. Discrepancies between Debtors’ Schedules and Mortgagees’ Claims ............................. 31D. Claims Objections ............................................................................................................. 39IV. IMPLICATIONS .................................................................................................................... 41A. Proof of Claim Process ..................................................................................................... 41B. Bankruptcy as a Home-saving Device .............................................................................. 44C. Sustainable Homeownership Policy.................................................................................. 46CONCLUSION ............................................................................................................................. 48
 
 Misbehavior and Mistake in Bankruptcy Mortgage Claims
3
INTRODUCTION
Families in financial distress are under great stress. The telephone rings withrepeated calls from debt collectors, each paycheck is at risk of garnishment, and the nextknock on the door could be a process server or a repo agent. For many families, thegreatest fear is losing their home to foreclosure. A home is not only most families’ largestasset, but also a tangible marker of their financial aspirations and middle class status. Athreatened or pending foreclosure can signal the end of a family’s ability to struggleagainst financial collapse and an unrecoverable tumble down the socioeconomic ladder.Bankruptcy offers these families one last chance to save their homes.
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Abankruptcy filing halts a pending foreclosure and gives families the right under federal lawto cure any defaults on mortgage loans over a period of years. The bankruptcy systemoffers refuge from the vagaries of state law foreclosure, substituting the protections of afederal court system and uniform legal rules to ensure that these families get one finalopportunity to preserve their homes.But this protection comes at a cost. Mortgage companies file proofs of claim withthe bankruptcy court for the amount of the mortgage debt. In turn, bankrupt debtors mustpay these claims or lose their homes. The balance between the family and the mortgagelender is clearly spelled out in the bankruptcy laws, specifying the manner in which theamount owed is to be established and obligating both the homeowner and the mortgagecompany to disclose information accurately.This claims process is well-established and, until now, uncontroversial.Homeowners—backed up by lawyers, policymakers, and news reporters—assume thatbankruptcy functions according to the official rules and, by following these rules, that itprovides a realistic opportunity for families to save their homes. The data revealed in thisArticle suggest, however, that home mortgage lenders often disobey the law and overreachin calculating the mortgage obligations of consumers. Such actions can cripple a family’sefforts to save its home and undermine policies to promote sustainable homeownership.This Article examines the actual behavior of mortgage companies in the consumerbankruptcy system. Using original data from 1700 recent Chapter 13 bankruptcy cases, Iconclude that mortgagees’ behavior significantly threatens bankruptcy’s potential to helpfamilies save their homes. Despite unambiguous federal rules designed to protecthomeowners and to ensure the integrity of the bankruptcy process,
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mortgage companiesfrequently fail to comply with the laws that governs bankruptcy claims. A majority of mortgage companies’ proofs of claim lack the required documentation necessary toestablish a valid debt. Fees and charges on bankruptcy claims often are identified poorlyand sometimes do not appear to be reasonable. Each year, mortgage creditors assert thatbankrupt families owe them an aggregate of at least one billion dollars more than thefamilies themselves believe are their outstanding mortgage debts. Although infractions arefrequent and irregularities are sometimes egregious, the bankruptcy system routinely
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Raisa Bahchieva et al.,
 Mortgage Debt, Bankruptcy, and the Sustainability of Homeownership
, in C
REDIT
M
ARKETS FOR THE
P
OOR
73 (Patrick Bolton & Howard Rosenthal eds., 2005) (stating that Chapter 13 bankruptcy isfrequently used by families who face foreclosure).
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See, e.g.
,
In re
Matus, 303 B.R. 660, 675 (Bankr. N.D. Ga. 2004) (“The [bankruptcy] statutes are designed toinsure complete, truthful and reliable information is put forward at the outset of the proceedings, so that decisionscan be made by the parties in interest based on fact rather than fiction.”).

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