Happy holidays!

As the weather turns colder here in midtown Manhattan, we at Shenwick & Associates wanted to take this time to wish you a happy, safe and warm holiday season and a very happy and healthy 2013. We also wanted to thank you for your friendship, your business, your referrals and your trust in us. Personal bankruptcy, business bankruptcy litigation, short sales, real estate closings and our emerging student loan debt practice continue to keep us busy as 2012 draws to a close! We're here for you now and in the upcoming year, and we look forward to working with you.

Forbes: Student Loan Crisis Solved -- Next Problem?

Raj Sabhlok, Contributor

Economists fear we’re racing towards another trillion dollar bubble of student loan debt. But there is a simple way to stop the madness now, before we blow any more taxpayer dollars — or our kids pay an even bigger price.

If financial history has taught us anything, it’s that high levels of debt and, more specifically, bad loans lead to financial crises. We have seen this numerous times including the Asian Debt Crisis in the late 90s, the more recent Greek Debt Crisis and, of course, the U.S. subprime mortgage debacle.

Financial crises have often been linked to government monetary policy. Arguably, the U.S. government was at least complicit with “easy money” credit policies that led to the housing boom and bust, which in large part triggered our most recent financial crisis.

Unfortunately, we are heading for another government-induced financial crisis — this time it is the $1 trillion in student loan debt. As of 2010, about one in five households in the U.S. have student loan–related debt of over $26,000. What is saddest about this pending crisis is that it will likely impact millions of student borrowers throughout their lives, because unlike credit card debt or mortgage debt, student loans can’t be discharged by bankruptcy.

How did we get here?

Ironically, as this crisis races toward a financial cliff, there has been no action by the government to curtail student loans, as would be the case in any other debt-related financial crisis. In 2011-12, the federal government issued 93 percent of all student loans.

Student loans are unique for a number of reasons, none perhaps more glaring than the fact that virtually nothing can disqualify an applicant from a federally-backed loan, excluding a prior student loan default or a drug conviction. A student loan is quite possibly the only loan that is not tied to credit worthiness or the ability to repay. Even more frustrating is that these easy loans are correlated to the rising cost of college — colleges have every incentive to raise costs knowing that there is an endless money supply.

Stop the madness

This crisis will likely end badly for the millions of student borrowers steeped in debt and with no ability to repay. For some reason, the government believes that everyone should go to college and is willing to give students any amount of money to put them on that righteous path. Inexplicably, this is all happening with no regard to whether students will be employable upon graduation or how they will pay back these monstrous loans. This madness must stop.

Like any loan, there needs to be some element of credit worthiness as William Bennett suggested last week in his article, “The looming crisis of student loan debt.” But one might ask, how can an unemployed student be creditworthy?

A simple solution

Admittedly student loans are riskier than most since there is no tangible asset to collateralize (although there certainly is a non-tangible asset — the student’s education). However, all educations are not created equal and should be “appraised” by lenders as part of a student loan determination.
College fees and student loan debt have a perverse symbiotic relationship. Rising costs in education beget rising student loan debt. It is puzzling why an art degree costs as much as a computer science degree when the job prospects of each are so vastly unequal.

Lenders, in this case the government, should make a fact-based determination of a student’s likelihood to graduate, to get a job and their expected income. Prospective students applying for loans can be evaluated for “credit worthiness” based on a score much like a FICO score. A student loan score would be based on a formula comprising their grade point average, major, and academic institution. Each of these variables is directly related to a student’s ability to get a job upon graduation and repay their loans. For example, a STEM (science, technology, engineering and mathematics) major at MIT would yield a higher score and loan compared to a religious studies major at a lesser ranked school.

While the solution I have outlined doesn’t offer relief to those deeply in debt today, it will stop more hot air going into the student loan balloon. And although I agree that everyone should have the right to go to college and study whatever they’d like, our government and colleges shouldn’t be reckless with our youth’s financial future — or taxpayer dollars.

Copyright 2012 Forbes.com LLC. All rights reserved.

Student loan debt strategies

As many readers of this blog are aware, defaulted student loans are generally not dischargeable in bankruptcy except in special circumstances. The debtor must show that: (1) he or she cannot maintain, based on current income and expenses, a minimal standard of living for the debtor and dependents if forced to pay off the student loan; (2) that additional circumstances exist indicating that this state of affairs is likely to persist for a significant portion of the repayment period of the student loan; and (3) that the he or she has made good faith efforts to repay the loans. That was the holding in Brunner v. New York State Higher Education Services Corp., 831 F.2d. 395 (2nd Cir. 1987), the leading case on student loans and bankruptcy, and its reasoning has been adopted by most federal appellate courts.

However, non-bankruptcy remedies are available under federal and state law for student loan debtors, including loan consolidation, deferment or forbearance:

1. Loan consolidation. Most federal student loans (except private loans) are eligible to be consolidated. However, if your loans are in default, you must meet certain requirements before you can consolidate your loans. Loan consolidation greatly simplify loan repayment by centralizing your loans to one bill and can lower monthly payments by giving you up to 30 years to repay your loans. You might also have access to alternative repayment plans you would not have had before, and you'll be able to switch your variable interest rate loans to a fixed interest rate.

2. Deferment. Deferment is a period during which repayment of the principal balance of your loan is temporarily delayed. Also, depending on the type of loan you have, the federal government may pay the interest on your loan during a period of deferment. The government does not pay the interest on your unsubsidized loans (or on any PLUS loans).

You are responsible for paying the interest that accumulates during the deferment period, but your payment is not due during the deferment period. If you don't pay the interest on your loan during deferment, it may be capitalized (added to your principal balance), and the amount you pay in the future will be higher.

3. Forbearance. If you can't make your scheduled loan payments, but don't qualify for a deferment, your loan servicer may be able to grant you a forbearance. With forbearance, you may be able to stop making payments or reduce your monthly payment for up to 12 months. Interest will continue to accrue on your subsidized and unsubsidized loans (including all PLUS loans).

There are two types of forbearance: discretionary and mandatory. For discretionary forbearance, your lender decides whether to grant forbearance or not. For mandatory forbearance, if you meet the eligibility criteria for the forbearance, your lender is required to grant the forbearance.

For more information about possible solutions to coping with your student loan debts, please contact Jim Shenwick

NYT: Child’s Education, but Parents’ Crushing Loans

By TAMAR LEWIN

When Michele Fitzgerald and her daughter, Jenni, go out for dinner, Jenni pays. When they get haircuts, Jenni pays. When they buy groceries, Jenni pays.

It has been six years since Ms. Fitzgerald — broke, unemployed and in default on the $18,000 in loans she took out for Jenni’s college education — became a boomerang mom, moving into her daughter’s townhouse apartment in Hingham, Mass.

Jenni pays the rent.

For Jenni, 35, the student loans and the education they bought have worked out: she has a good job in public relations and is paying down the loans in her name. But for her mother, 60, the parental debt has been disastrous.

“It’s not easy,” Ms. Fitzgerald said. “Jenni feels the guilt and I feel the burden.”

There are record numbers of student borrowers in financial distress, according to federal data. But millions of parents who have taken out loans to pay for their children’s college education make up a less visible generation in debt. For the most part, these parents did well enough through midlife to take on sizable loans, but some have since fallen on tough times because of the recession, health problems, job loss or lives that took a sudden hard turn.

And unlike the angry students who have recently taken to the streets to protest their indebtedness, most of these parents are too ashamed to draw attention to themselves.

“You don’t want your children, much less your neighbors and friends, knowing that even though you’re living in a nice house, and you’ve been able to hold onto your job, your retirement money’s gone, you can’t pay your debts,” said a woman in Connecticut who took out $57,000 in federal loans. Between tough times at work and a divorce, she is now teetering on default.

In the first three months of this year, the number of borrowers of student loans age 60 and older was 2.2 million, a figure that has tripled since 2005. That makes them the fastest-growing age group for college debt. All told, those borrowers owed $43 billion, up from $8 billion seven years ago, according to the Federal Reserve Bank of New York.

Almost 10 percent of the borrowers over 60 were at least 90 days delinquent on their payments during the first quarter of 2012, compared with 6 percent in 2005. And more and more of those with unpaid federal student debt are losing a portion of their Social Security benefits to the government — nearly 119,000 through September, compared with 60,000 for all of 2007 and 23,996 in 2001, according to the Treasury Department’s Financial Management Service.

The federal government does not track how many of these older borrowers were taking out loans for their own education rather than for that of their children. 

But financial analysts say that loans for children are the likely source of almost all the debt. Even adjusted for inflation, so-called Parent PLUS loans — one piece of the pie for parents of all ages — have more than doubled to $10.4 billion since 2000. Colleges often encourage parents to get Parent PLUS loans, to make it possible for their children to enroll. But many borrow more than they can afford to pay back — and discover, too late, that the flexibility of income-based repayment is available only to student borrowers.

Many families with good credit turn to private student loans, with parents co-signing for their children. But those private loans also offer little flexibility in repayment.

The consequences of such debt can be dire because borrowers over 60 have less time — and fewer opportunities — than younger borrowers to get their financial lives back on track. Some, like Ms. Fitzgerald, are forced to move in with their children. Others face an unexpectedly pinched retirement. Still others have gone into bankruptcy, after using all their assets to try to pay the student debt, which is difficult to discharge under any circumstances.

The anguish over college debt has put a severe strain on many family relationships. Parents and students alike say parental debt can be the uncomfortable, unmentionable elephant in the room. Many parents feel they have not fulfilled a basic obligation, while others quietly resent that their children’s education has landed the family in such difficult territory.

Soon after borrowing the money for Jenni’s education, Ms. Fitzgerald divorced and lost her corporate job. She worked part-time jobs and subsisted on food stamps and public assistance.

“I don’t really feel guilt, but I do know that this is all because of a loan taken out on my behalf,” said Jenni, who has a different last name and agreed to be interviewed only if it would not be disclosed. “I asked my mother to move in with me, because I couldn’t stand it that she was living in a place with no heat and a basement that kept flooding.”

The unusual arrangements, and strained family dynamics, can be awkward. Like Jenni, many with student debt problems agreed to be interviewed only on the condition that they not be identified because they did not want to expose their financial troubles.

“It makes you feel like a failure as a parent, to be unable to help your children and to have all your hard work end in a pile of debt,” said one New Jersey man, who took out a second mortgage of $280,000 to help cover his children’s college costs. “I sent my older kids to private colleges, and I was happy to do it because it’s how you help them get started off. But I can’t do it for the youngest, and I haven’t even been able to start the conversation with him.”

Ms. Fitzgerald said she had little hope of a comfortable old age. She has no health insurance. She knows that the odds of finding a good job in her 60s, with no college degree, are slim — and she knows that the government will take part of her Social Security, in payment of her debt, which she said had now ballooned to about $40,000 because of penalties for nonpayment. At one point, she said, the Internal Revenue Service seized a $2.43 tax refund.

Jenni has volunteered to take on her mother’s debt, but Ms. Fitzgerald has refused, saying it is her legal and moral obligation, and anyway, Jenni has her own loans to pay off — about $220 a month — and not much discretionary income. The very suggestion that Jenni might take on her debt annoys her.

“Don’t you think she is doing enough for me now by supporting me a hundred percent, financially, by my living with her and her extending her resources?” Ms. Fitzgerald asked. “The whole idea was for her to get a college education so she can succeed in life; it is hard enough just to do that without being burdened with her mother’s welfare, like I was her child.”

Jenni occasionally jumped in with explanations or clarifications, as she and her mother sat in the living room discussing their situation. When Ms. Fitzgerald talked of being depressed last year, so overwhelmed by the cartons of documents and dunning letters that she threw them all out, Jenni said gently, in an almost maternal tone, “But you’re doing much better now.”

Many young people live with deep guilt that their education has pushed their parents into debt, and perhaps ruined their credit rating. Even those who do not know exactly how much money their parents have, or how much they owe, worry about how their debt will affect their parents’ lives.

One 27-year-old man from East Texas, who earned a bachelor’s degree in California, is now nearing graduation with another bachelor’s degree, in Russian literature, from Columbia University. He said he did not know how much debt he and his mother had accumulated in the course of his educational wanderings, sounding almost paralyzed by the prospect of talking to her about it.

“I should know how much I owe, and it’s sad that I don’t,” he said. “I feel like I’m standing on the train track and I can hear the rumble of the train coming, and I don’t know how hard the train will slam into me.”

In one extreme case, student debt, and the constant creditor calls, were mentioned in a suicide note by the stepfather of a young law school graduate. The guilt has been crushing for the graduate.

Teresa Tosh, 56, a mother of five who works for the county government in Tulsa, Okla., had co-signed large graduate and law school loans for one of her sons, Jacob, who has a different last name. In total, he owes more than $200,000 on his federal loans, in addition to more than $100,000 on the private student loans his mother co-signed.

But like many recent law graduates, Jacob had trouble finding a job, and when he finally found one, an hour from home, the salary was nowhere near enough to cover loan payments. Creditor calls to both Jacob and to his mother became more and more frequent.

Jacob talked to the collectors when they called, and tried to work out payments as best he could. But shortly after one call ended, he and his mother said, the phone would ring again: another collection agent, in another part of the country. Ms. Tosh’s husband, George, a Vietnam veteran who worked from home, concluded that Jacob was lying about trying to work things out, deceiving Ms. Tosh, ruining her credit and leaving her holding the bag.

The household tension grew intense, and in July 2010, Mr. Tosh shot himself, leaving a note saying that he could no longer stand the incessant calls from Sallie Mae, one of the lenders.

“Jake has destroyed us. You can’t tell me that sally mae is getting paid when they keep calling all day, every day,” he said in a note to his wife. “I can’t even answer the phone in my own home no more. I can’t live like this no more.”

Ms. Tosh said she was “not naïve enough to think the Sallie Mae calls were the only reason” that her husband killed himself. “But they were adding a lot of stress,” she said. “They’d never stop calling.”

A few months after the suicide, Jacob moved to Dallas and got a document-review job. The pay is not enough to meet his loan payments — or even full interest — but his creditors agreed to let him make partial-interest-only payments for two years. While his balance continues to grow, that arrangement protected his mother from payment demands for two years.

“It’s made my life so much more stressful and guilt-filled because I know that it affects her,” Jacob said. “I barely have enough money to pay the bills, but if I miss by a day, they call her.”

Jacob pays about $1,200 a month toward the debt, more than he pays for rent. He and his mother are carefully rebuilding their relationship, after a period of great tension. Ms. Tosh traveled to Dallas for his birthday. 

“She’s been really good about it,” Jacob said. “It’s always there, but she doesn’t bring it up.” 

Copyright 2012 The New York Times Company.  All rights reserved.

Lien stripping in bankruptcy

As we have discussed in prior e-mails, based on the depressed market for real estate in New York City and the surrounding areas, many co-ops, condos and houses are "underwater." As we have discussed, "underwater" means that the value of the property is less than the amount of the mortgages and tax liens that encumber the property. Let's start with an example to illustrate the point:

Three years ago an individual bought a house for $750,000. The first mortgage on the house is $650,000 and there is a second mortgage on the house for $50,000. A recent appraisal valued the house at $600,000. Since the appraised value of the house ($600,000) is less than the amount of the mortgages that encumber the house ($650,000 + $50,000=$700,000), the house is "underwater" and the second mortgage is totally unsecured. What can a client do under this fact pattern?

In bankruptcy, if the home owner files for Chapter 13 bankruptcy, then they may avoid the second mortgage for $50,000 pursuant to §1322(b)(2) of the Bankruptcy Code. This result is allowed by the Second Circuit in Pond v. Farm Specialist Realty (In re Pond), 252 F. 3d 122 (2001). When the second mortgage of $50,000 is voided, it is no longer deemed to be a second mortgage against the house; but it is in fact an unsecured claim, and must be treated as such in a Chapter 13 Plan. In order to obtain this result, the homeowner or homeowners must file for Chapter 13 bankruptcy. They must have the property appraised to determine its value and then they must commence an adversary proceeding (litigation in the Bankruptcy Court) pursuant to Rule 7001(2) of the Federal Rules of Bankruptcy Procedure to determine the value of the property and the mortgage and to have the mortgage voided.

The next issue is whether a homeowner can accomplish this result in a Chapter 7 bankruptcy, which results in a "fresh start" and the liquidation of debts. Interestingly, in the Eastern District of New York (which is Brooklyn, Queens, Long Island and Staten Island), there is a split among the bankruptcy judges as to whether a Chapter 7 debtor can strip off a second mortgage in a property that is underwater. Judge Eisenberg has ruled in two cases ( In re Lavelle, 2009 WL 4043089 (Bankr. E.D.N.Y. 2009) and Smoot v. Wachovia Mortgage (In re Smoot), 465 B.R. 730 (Bankr. E.D.N.Y. 2011)) that a Chapter 7 debtor can strip off an unsecured second mortgage. Judge Grossman in Pomilio v. MERS (In re Pomilio), 425 B.R. 11 (Bankr. E.D.N.Y. 2010) has rules that the strip off of a second mortgage is not allowed in Chapter 7 bankruptcy cases.

Accordingly, owners of property that is "underwater" should consider a bankruptcy filing to void their second mortgage if they desire to retain the property in the bankruptcy. Any individuals or clients that have questions regarding the strip off of mortgages in bankruptcy should contact Jim Shenwick.

Deficiency judgments

Continuing our series of e-mails on real estate workouts, many clients are concerned about potential exposure to deficiency judgments resulting from real estate foreclosures. The New York law that deals with deficiency judgments is § 1371 of the Real Property Actions & Proceedings Law. The law provides that:

1. A plaintiff in a mortgage foreclosure action may bring an action for a deficiency judgment if the defendant has been personally served in the action.

2. The action for the deficiency judgment must be made within 90 days after the foreclosure sale.

3. The law provides that the deficiency judgment shall be equal to the amount the defendant is liable to the plaintiff (as determined by the judgment), plus interest, plus the amount owing on any subordinate liens and encumbrances, including interest, costs and disbursements, including referee's fees, less the market value of the property as determined by the court at the time of the foreclosure sale. Accordingly, if the value of the property is greater than the deficiency owed, the plaintiff will not be able to obtain a deficiency judgment.

Notwithstanding the language in RPAPL § 1371, before commencing deficiency judgment actions, secured creditors (such as banks) go through a calculation. They ask themselves the following questions:

1. If we bring a deficiency action, does the defendant have assets or earnings to satisfy the judgment? For example, if the bank believes that the defendant will file Chapter 7 personal bankruptcy to protect his or her assets, or if the defendant is "judgment proof," then they will not commence the action. Some borrowers who do have the ability to pay some or all of the judgment will come forward and offer to settle before an action for deficiency is commenced.

2. Does the defendant have the potential for good future earnings (such as a medical doctor), such that if the creditor obtains the judgment (which is good for 20 years under New York State law), they will be able to collect the judgment from future earnings?

3. What is the fair market value of the property? As mentioned above, the court will determine the fair market value at the time of the foreclosure sale, which can become a battle of appraisals, so creditors must prepare to bring in expert witnesses to testify on this issue.

4. How long will it take and how much will it cost to obtain and collect the judgment?

5. Is the deficiency a result of a "strategic default"? A "strategic default" involves a borrower who has the ability to pay his or her mortgage but chooses not to. Often that decision is tied directly to the property being "underwater" (the fair market value of the property is less than the outstanding liens encumbering the property (mortgages, home equity lines of credit, etc.)). Loan originators rely heavily on their servicers (the entities that are responsible for day–to–day management of mortgage accounts) to determine if a borrower is a strategic defaulter and then makes a determination whether to seek a deficiency judgment.

Clients or colleagues having questions about deficiency judgments should not hesitate to contact Jim Shenwick.