Invisible Mortgages in Bankruptcy

Abstract

This paper identifies a previously unexplored channel through which bankruptcy affects consumer welfare: the presence of retained mortgages and their invisibility in post-bankruptcy credit reports. Using credit bureau data, this paper reveals that approximately 70% of mortgagors in Chapter 7 bankruptcy and 56% of those in Chapter 13 bankruptcy had mortgages in good standing when they first filed. Similarly, court records show that 74% of mortgagors in Chapter 7 bankruptcy intended to retain their mortgages, and only 7% of properties intended for retention were foreclosed within three years, compared to 69% of those intended for surrender. This demonstrates that, surprisingly, most homeowners who filed for bankruptcy nevertheless did not default on their mortgages. However, once the homeowners filed, nearly 79% of their mortgages disappeared from their credit reports or stopped being updated. In other words, the homeowners stopped getting credit for keeping their mortgages current; their mortgages became invisible. Using event studies, this paper shows that this mortgage invisibility harms these homeowners, leading to a 15 to 30-point reduction in their credit scores, a $1,500 decrease in their credit card limits, and a 1 percentage point increase in their auto loan interest rates. Therefore, this paper advocates for reporting practice changes to better reflect the financial realities of retained mortgages in bankruptcy.

Keywords: Bankruptcy, Household Debt, Debt, Mortgages, Credit Report