The Helping Families Save Their Homes in Bankruptcy Amendment authorizes federal bankruptcy courts to modify the terms of mortgages on certain primary residences. Bankruptcy law currently bars modifications on primary residences, while allowing modifications for vacation homes, family farms, and yachts. The bill would permit bankruptcy courts to restructure the debt on home mortgages by reducing the principal owed, extending the repayment period, and reducing interest rates. Under the bill, eligibility is limited to homeowners with mortgages originated before 2009 that are worth less than $625,000, 60 days delinquent, and subject to a notice that a foreclosure may be commenced.
To be eligible for modification in bankruptcy, a homeowner must seek a loan modification or refinancing outside of bankruptcy first. The amendment then restricts the situations in which mortgage modification in bankruptcy is available and restricts the methods of modification, including limiting the use of principal write downs, based on the homeowner’s income, debt burden, and the type of modification or refinancing plan offered to the homeowner outside of bankruptcy. If a bankruptcy court reduces the value of a mortgage and the value of the home later rises, the lender is entitled to receive 50 percent of the net proceeds from the sale of the property.
Additionally, the legislation protects homeowners from liability for fees incurred while a bankruptcy is being processed and permits bankruptcy courts to wave penalties on homeowners who pay their mortgages in full ahead of schedule.
The Middle-Class Position:
Middle-Class Supports. As the economy and the housing and job markets worsen, middle-class households continue to lose equity in their homes and are less able to afford their mortgage payments. The difficulty is compounded for those locked into predatory mortgages with high interest rates. The federal government and the mortgage industry’s continued failure to address the foreclosure crisis adequately could result in as many as 8.1 million foreclosures by 2012. Despite widespread calls for action to confront the crisis, foreclosures increased 81% in 2008. Voluntary mortgage modifications by lenders and banks, encouraged by policymakers in place of comprehensive federal action, have failed to make mortgages more affordable and prevent widespread foreclosures.
Extending the same bankruptcy protections to primary residences that currently apply to luxury yachts and vacation homes is not only fair, but will reduce foreclosures by about 20%, according to Credit Suisse, and benefit about 800,000 households, according to the Center for Responsible Lending. Strengthened bankruptcy protection is also beneficial to middle-class families who are not themselves facing foreclosure: the 2.4 million subprime foreclosures that the Center for Responsible Lending predicts will occur in 2009 will result in a $352 billion decline in property values for homes in neighborhoods surrounding those foreclosures, with an average decrease in property value per home of $8,667. Preventing foreclosures in those neighborhoods will keep property values up, benefiting all homeowners. Indeed, an analysis by the Center for Responsible Lending found that similar legislation would avoid 600,000 foreclosures and thus maintain $72.5 billion in wealth for families not facing foreclosure. Modification of mortgages in bankruptcy will help maintain property values, while keeping middle-class families in their homes, limiting the self-reinforcing spiral of foreclosures and falling home prices.
Additionally, the bankruptcy provision provides a powerful incentive to banks to offer homeowners affordable loan modifications in order to avoid costly bankruptcy proceedings over which they have little control.
From the Experts:
“[B]ankruptcy law is wildly off-kilter in how it treats homeownership. Under current law, courts can lower unreasonably high interest rates on secured loans, reschedule secured loan payments to make them more affordable and adjust the secured portion of loans down to the fair market value of the underlying property -- all secured loans, that is, except those secured by the debtor's home. This gaping loophole threatens the most vulnerable with the loss of their most valuable assets -- their homes -- and leaves untouched their largest liabilities -- their mortgages.” – Jack Kemp, President George H.W. Bush’s Secretary of Housing and Urban Development, January 29, 2008
“Bankruptcy modification would permit homeowners to bypass all of the obstacles to voluntary loan modification—practical outreach and staffing problems, restrictive pooling and servicing agreements, and improperly motivated mortgage servicers. It could be administered immediately through the existing bankruptcy court system. Mortgage modification in bankruptcy would not impose any direct costs to taxpayers.” – Congressional Oversight Panel of the Troubled Asset Relief Program, March 6, 2009
Beyond this Bill:
Critics of modifying primary mortgages in bankruptcy worry that interest rates will rise as a result, that the federal government is bailing out irresponsible borrowers, and that the provision will encourage bankruptcy, overwhelming bankruptcy courts. None of these criticisms is valid. Restricting eligibility to current mortgages in danger of foreclosure means that future mortgages will not qualify for modification. Thus, lenders will not raise interest rates on future mortgages based on the risk of modification in bankruptcy. Indeed, research demonstrates that mortgage markets (and interest rates) are not, in fact, influenced by the risk of bankruptcy modification. Further, the bankruptcy modification provision will protect all homeowners from the current housing crisis by mitigating house price declines. Foreclosures affect not only the families who lose their homes but entire neighborhoods, as property values decline with the appearance of unkempt properties, abandoned homes, and increased crime. Finally, concerns that the modification provision will incentivize bankruptcy are exaggerated. Not only is the provision limited to mortgages at risk of foreclosure, but bankruptcy itself is unpleasant, damaging credit and subjecting living expenses to court review.
The amendment’s restrictions on eligibility incentivize modification outside of bankruptcy and mean that only recalcitrant lenders unwilling to work with struggling homeowners will face the prospect of bankruptcy modification.
Still, modification of mortgages in bankruptcy will not solve the housing crisis. Further action to address widespread foreclosures – including a moratorium on foreclosures and a mechanism to require modification of mortgages outside of bankruptcy – is necessary. President Obama’s Homeowner Affordability and Stability Plan is an important component of such a comprehensive approach, but one whose efficacy is not yet proven.
The Amendment restores some fairness to bankruptcy law, which was changed in 2005 to treat middle-class debtors more harshly. Further legislation is necessary to reform the worst provisions of that bill that make it harder for debtors to get a fresh start.
Number of properties on which foreclosure notices were filed in 2008: 2,330,483
Percentage increase in total properties on which foreclosure notices were filed since 2007: 81
Number of foreclosures likely between 2009 and 2012, according to Credit Suisse: 8.1 million
Proportion of all households with a mortgage that will lose their home to foreclosure: 1:6
Number of homes that the Center for Responsible Lending estimates will be saved from foreclosure by the bankruptcy modification provision: 800,000
Average decrease in the property value of each home in the neighborhoods surrounding the foreclosures that are likely to occur in late 2008 and in 2009, in dollars: 8,667
Testimony of Adam J. Levitin, Georgetown Associate Professor of Law, on the Helping Families Save Their Homes in Bankruptcy Act, before the House Judiciary Committee
FinancialStability.gov, the U.S. Treasury’s site with details about the President’s Homeowner Affordability and Stability Plan
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