68,800 personal bankruptcies were filed in California during 2019. This is down 73% from the peak of 258,200 bankruptcies filed in 2010. Choosing bankruptcy has limited benefits for individuals, including delaying foreclosure, as bankruptcy proceedings extend the foreclosure process by several months. 

The number of personal bankruptcy filings consistently decreased following the end of the Great Recession, bottoming and remaining roughly level since 2016. Personal bankruptcies increased very slightly in 2019, as the economic expansion passed its peak and the market turned toward a recession.

In 2020, the added complications of a global pandemic and resulting financial crash will push what was to be a moderate business recession into a more significant downturn. For the housing market, a steep reduction in home sales volume will see home values decrease – unless the Federal Reserve (the Fed) goes negative this year, which will help keep home values afloat. Homeowners who see their home values diminish are more likely to throw in the towel when financial stress occurs. As home values struggle in response to slowing sales, expect more bankruptcies to occur in the coming years, peaking in 2022-2023.

Updated April 23, 2020. Original copy released January 2010.

Chart update 04/23/20

2019
2018 2017
Total CA Bankruptcies
68,800
67,900
70,600

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 districts with the highest number of personal bankruptcy filings in 2019 were:

  • Central California, with 38,200;
  • Los Angeles, with 15,800; and
  • Riverside, with 11,600.

The majority if these personal bankruptcy filings were completed 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.