In an effort to prevent a predicted siege of foreclosures, Representatives Brad Miller (D-NC) and Linda Sánchez (D-CA) have introduced legislation that would repeal the mortgage exception in the bankruptcy code, allowing a judge to change the priority value of primary residence mortgages or alter interest rates.
Called the Emergency Home Ownership and Mortgage Equity Protection Act (H.R. 3608), the bill would give a bankruptcy judge the option of restructuring the amount an insolvent person owes on the mortgage on a primary residence so that only the portion of the loan principal that doesn't exceed the market value of the property would receive high priority. Alternatively, the judge could order a lower loan interest rateex.
Under this legislation, the portion of the mortgage principal that exceeds the market value of the home would be treated as an unsecured liability and not given preferential treatment, meaning that the amount could be discharged in a bankruptcy proceeding.
Traditionally mortgage payments on primary residences, like tax liabilities, have been sacred territory in bankruptcy negotiations, not allowed to be tampered with by the courts. But in the current economic climate, with analysts predicting as many as 600,000 foreclosures in the next two years, the Miller-Sánchez bill is getting serious attention as a means of averting a crisis.
The Center for Responsible Lending (CLR), a nonprofit research and policy organization dedicated to working to eliminate abusive financial practices, offers the following list of possible outcomes that could result if the Miller-Sánchez legislation is enacted:
Being able to modify loans on primary residences would allow lenders to get paid more than what they might in a foreclosure. In foreclosures, lenders incur expense to arrange for a sale, they often sell at below-market prices, and they forego future interest.
"Loan modification … just allows the process to reach a resolution without a homeless family and a boarded-up home as the unnecessary by-products," said CRL's senior vice president Eric Stein in a written testimony before a House Judiciary subcommittee.
Allowing homeowners to avoid foreclosure can preserve neighborhood property values.
Rather than increasing the volume of bankruptcy filings, the knowledge that mortgages can be adjusted in bankruptcy might encourage lenders to work with borrowers to reach a settlement out of court; however contractual constraints on mortgage modifications might prevent this from occurring.
Other analysts have suggested that if mortgages can be adjusted in bankruptcy, investors in mortgage debt might change their valuation processes due to increased risk. The potential exists for mortgage lenders to raise rates as a protective measure, or be pickier about lending to potential home purchasers who might pose higher credit risks, thus squeezing lower income or higher risk borrowers out of the market. Some analysts contend that this process would harm the very people the bill is trying to help.
Senator Dick Durban (D-IL) has introduced similar legislation in the Senate. Called the Helping Families Save Their Homes Act, Durbin's bill would allow an insolvent homeowner to file for Chapter 13 bankruptcy and work with a judge and the lender to modify the mortgage so that the debtor can make affordable payments and keep the home.
Included in the Durbin bill are provisions that would:
Allow modifications to mortgage loans on the debtor's primary residence.
Allow a bankruptcy judge to extend the time frame debtors are allowed for repayment.
Waive the bankruptcy counseling requirement for insolvent homeowners whose houses are scheduled for foreclosure sale, in an effort to save time and stop the foreclosure process.