The greatest fear of many families in serious financial trouble is that they will lose their homes. Bankruptcy offers a last chance for families save their houses by halting a foreclosure and by repaying any default on their mortgage loans 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 protective elements of the federal bankruptcy shield vulnerable homeowners from harm.
This Article examines the actual behavior of mortgage companies in consumer bankruptcy cases. Using original data from 1700 recent Chapter 13 bankruptcy cases, I conclude that mortgage servicers frequently do not comply with bankruptcy law. A majority of mortgage claims are missing one or more of the required pieces of documentation for a bankruptcy claims. Fees and charges on claims often are poorly identified and do not appear to be reasonable. The bankruptcy data reinforce concerns about the overall reliability of the mortgage service industry to charge homeowners only the correct and legal amount of the debt and to comply with applicable consumer protection laws. Mistakes or misbehavior by mortgage servicers can have grave consequences. Bloated claims can jeopardize a family’s ability to save their home in bankruptcy. On a system level, mistakes or misbehavior by mortgage servicers undermine America’s homeownership 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 chilling reminder of the limits of formal law to protect consumers. Imposing unambiguous legal rules does not ensure that a system will actually function to safeguard the rights of parties. Observing the reality that laws can underperform or even misfire has crucial implications for designing legal systems that produce acceptable and just behavior.