Over 71,000 personal bankruptcies were filed in California during 2016. This is down 72% from the peak of 253,000 bankruptcies filed in 2010. Choosing bankruptcy has limited benefits for individuals. One of these benefits is putting off foreclosure, as bankruptcy proceedings extend the foreclosure process by several months. 

The number of personal bankruptcy filings has decreased each year since the end of the 2008 recession, returning to the average levels seen during the 1990s and early 2000s.

Personal bankruptcies decreased in 2016 due to a stagnating economic recovery. However, expect bankruptcies to rise marginally in 2017, fueled by rising mortgage rates and decreasing home prices. Many individuals waiting for solvency will get frustrated waiting and choose to throw in the towel, as is normal at the tail end of a recovery.

Updated 03/23/2017. Original copy released 01/04/2010.

1100
Chart: Personal Bankruptcies

Chart update 03/23/17

2016
2015 2014
Total CA Bankruptcies
71,322
79,663
98,849

The number of personal (nonbusiness) bankruptcy filings has decreased each year since the end of the 2008 recession. At the end of 2014, personal bankruptcy levels had fallen below the average levels seen during the 1990s and early 2000s.

California counties with the highest number of personal bankruptcy filings in 2015 were:

  • Los Angeles, with 18,000;
  • San Bernardino and Riverside, with 12,000 total;
  • San Diego, with 8,000; and
  • Orange, with 5,000.

The majority if these personal bankruptcy filings were through Chapter 7.

Two forms of bankruptcy

Two separate bankruptcy procedures exist, both governed by federal law.

Chapter 7 bankruptcy requires the insolvent homeowner in bankruptcy to repay their debt from whatever assets they possess, unless those assets are lower than state-allowed levels of assets and income. In Chapter 7 bankruptcy, a home without equity is counted among these assets, and foreclosed upon.

Chapter 13 bankruptcy, on the other hand, requires the homeowner to repay their delinquent debts over a longer period of time than contracted for, after deducting reasonable living expenses.

The Chapter 13 repayment plan can include the homesteaded sale of the owner’s home, if the home has any equity in the home. Bankruptcy law no longer permits a homeowner’s mortgage to be reduced by a bankruptcy court (a cramdown, or principal reduction). However, Chapter 7 bankruptcy voids any deficiency obligations on recourse mortgage refinancing, just as it voids all unsecured debt with a value exceeding the amount of the homeowner’s nonexempt assets.

In addition to putting an immediate stop to lender collection efforts, the process of filing bankruptcy allows a homeowner to pay delinquent mortgage payments over a three-to-five year period. Troubled homeowners often choose to file Chapter 13 Bankruptcy in order to discharge their non-mortgage (unsecured) personal debts, and then use the newly freed funds to make future payments on their mortgages.

The homestead exemption

Bankruptcy laws do enforce California homesteads, which range from $75,000 for single homeowners without dependents to $175,000 for the aged or disabled. For positive equity homeowners, this exemption acts as an incentive to file bankruptcy in order to avoid unsecured debts and free up cash by making it available under the homestead.

On the other hand, the homestead exemption has no effect on the priority or payment of an owner’s mortgage. The bankruptcy process adversely affects lenders who have obtained involuntary liens (judgment liens) against the homeowner’s title.

Bankruptcy and foreclosure

The most important aspect of bankruptcy, from the point of view of mortgage lenders, is the “automatic stay” provision. This provision of bankruptcy law also delivers the most direct and immediate results for troubled homeowners. Any owner who files bankruptcy immediately places an automatic stay on all collection efforts, including foreclosure sales.

Lenders prefer to quickly move to a foreclosure sale, take title to the property or what proceeds they can and cut their losses, and are thus hamstrung by the automatic stay provision. They are forced to wait until a bankruptcy court allows them to proceed. The stay provision increases the lender’s costs of dealing with a homeowner who does not maintain their mortgage payments while in bankruptcy.

On average, filing Chapter 7 bankruptcy extends the foreclosure process from six months to a year. Chapter 13 delays the foreclosure sale even longer, often drawing it out to a year and a half. A homeowner who files bankruptcy without the ability to make payments on their mortgage merely extends the time before the eventual foreclosure sale. For the lender, the bankruptcy process increases the risk the home will be damaged or otherwise devalued before the sale takes place, increasing the lender’s eventual loss.

Lenders thus have a vested interest in government regulations that make it difficult for homeowners to obtain relief on their mortgages in bankruptcy, and they intend to keep their hard fought gain of a cramdown-free bankruptcy law intact. Lenders don’t want the threat of a bankruptcy judge endowed with the power to reset the loan balance at exactly the amount the security for the loan is worth (which, of course, is all the lender can expect to get from foreclosure anyway).

When bankruptcy is unavoidable, lenders want to get out of bankruptcy court as quickly as possible. Often they can be persuaded to agree to a short sale in order to hasten the process and cut their losses. Bankruptcy can thus be an effective way for homeowners to force the lender’s hand.

Costs and benefits of bankruptcy

So does filing bankruptcy, and thereby discharging unsecured debt and putting off a potential foreclosure sale, actually help homeowners pay their mortgages, or do the other costs of bankruptcy cancel out the benefits? Evidence is mixed, but homeowners and their attorneys certainly seem to believe that bankruptcy can be beneficial. Troubled homeowners already make up the majority of those who file for Chapter 13 bankruptcy (studies in other states found that over 80% of filers were paying for homes with a loan to value ratio (LTV) over 90%).

Of the total number of homeowners who file bankruptcy, only about 33% successfully kept their homes. It is certain that bankruptcy does, at least on occasion, have a positive effect for those desperate homeowners who turn to it as a last resort, and it is also sure that bankruptcy will almost always have a negative effect for lenders.

Equally important, homeowners who file for bankruptcy will find later that their past bankruptcy interferes with their future ability to get mortgage financing.

For a more comprehensive look at personal bankruptcy’s role in retaining or losing a home to foreclosure, see Residential Housing and Personal Bankruptcy, from the Philadelphia Federal Reserve.