Let Bankruptcy Judges Help in the Foreclosure Crisis

by Peter Vernon on Bankruptcy

A good question to be asked by people nowadays in this economic recession is why the Bankruptcy Court is not permitted to be one of the solutions to the foreclosure crisis?

According to Chapter 13 – wherein bankruptcy for individuals who have failed to keep up with their debts but do not wish to be harsh to their creditors – new terms on automobiles, boats and vacation residences can be worked out by bankruptcy judges. This is legally called the cram-down process.

However, judges are strictly prohibited to cram down a mortgage debt on a principal house. Debtors can either comply with the original terms of the loan or undergo foreclosure. This rule is absolutely ridiculous. Judges can help you keep your assets by modifying loans on possessions that are relatively expendable, but what about your home?

A measure supported by Michigan Representative John Conyers Jr. that will likely pass the House could fix this inequality. However, it may not be enough to gain 60 votes to become a stand-alone bill. Bankers are still against the mortgage cram-downs. Last month, when Citigroup Inc. declared that it supports the change, other banks have regarded the company as a traitor.

Moreover, the mortgage lobby states that cram-downs would incite an impulsive rush to the Bankruptcy Court. Mortgage rates could go sky-high even for commendable home buyers since lenders would perceive more danger in the mortgage industry.

On the contrary, cram-downs are essentially bound to mortgages underwater, or those with balances surpassing the market value of the property. Such loans are already at the risk of foreclosure, so the lenders deal with massive losses unless someone similar to a bankruptcy judge knows how to create a solution.

For example, in the primary proposal in Congress, a classic strategy would work like this for a debtor who owes $225,000 at an adjustable-rate mortgage at a home currently priced at $200,000: the judge decreases the balance by $200,000. The extra $25,000 transforms into an unsecured debt towards the lender when the case concludes, or a process identified as the strip down.

The remaining loan can be modified by the judge through changing the adjustable rate into a set market rate, adding up 1 percent to 3 percent as a risk payment. Seasonal rate adjustments, balloon expenses, pre-payment costs, etc. can be deleted by the judge and prolong it up to 40 years.

A house would only go into foreclosure if the judge concludes that no form of combination of these modifications could create a mortgage in which a debtor could cope with. This procedure tackles the rights of bondholders as one huge barrier to mortgage workouts. The separation of the body servicing the loan from the faceless investors or loan owners was made possible through the securitization of housing loans.

Servicers are worried that if they change a mortgage to maintain payment flowing instead of foreclosing, then they will be charged by bondholders even though the outcome is possibly better in the future. The service can obtain legal cover if a judge commands the modification.

No one believes that the cram-down is perfect, nor is it the single solution to the foreclosure crisis. But its advantage is that its focal point is the debtors that are really serious in keeping their houses and are the least expected to re-default.A good question to be asked by people nowadays in this economic recession is why the Bankruptcy Court is not permitted to be one of the solutions to the foreclosure crisis?