Home prices continue to languish badly in spite of signs of a slowly recovering economy. While many people who found themselves unemployed as a result of the financial meltdown of 2008, the housing market has struggled even more to recover. Local markets are flooded with a surplus of inventory as many try to downsize or relocate. This is compounded by a record number of foreclosures and short sales, which drive prices down. More stringent loan criteria from lenders can delay or undo closings and preventing sales to go through. Zillow.com reported that the average home price in Portland for October 2010 was $233,000, down from the July 2007 high of $299,000. These statistics have important implications for homeowners contemplating bankruptcy, or drowning under high interest second mortgages.
At the height of the housing bubble, one hundred percent financing was in vogue by virtue of so-called 80/20 mortgages, i.e., a first mortgage for eighty percent of the purchase price, and a second mortgages for the remaining twenty percent. The second mortgage is typically at a much higher interest rate than the first mortgage, and may carry other burdens such as a balloon payment or pre-payment penalty.
In Chapter 13 bankruptcy (also referred to as a wage earner repayment plan), it is possible to “strip” liens, such as a second mortgage. This is possible where the first mortgage exceeds the value of the collateral, i.e., the home. As a result of falling housing prices, this is often the case. Noting the regional average drop in housing price is twenty-two percent from the height of the market, it is highly likely that the average home purchased in 2007 is worth less than eighty percent of the original purchase price, in spite of efforts by the federal government to spur new home buying.
In this scenario, a where a home has fallen below the value of the first mortgage, the homeowner can seek to “strip” the second mortgage, by converting it into unsecured debt, and then discharging it through the bankruptcy. The net effect is to void the second mortgage. If the debtor can afford to continue making payments on the first mortgage, they can stay in the home. This can lower the total house payment by hundreds or even thousands of dollars.
Even though the general economy has shown recent signs of recovery, the housing market is still very soft. Some estimates indicate that Oregon has more than forty months of inventory bogging down housing prices. Thus, for years to come, the anemic housing prices will favor debtors who bought in at the height of the market with 80/20 mortgages, and allow these homeowners to strip or eliminate their second mortgages, while staying in their homes with only the payment on the first mortgage to pay. At the same time, homeowners can eliminate other unsecured debt, such as credit card bills, medical bills, and certain other debts.