A change in the law to permit home owners to FORCE a modification on mortgage lenders in Chapter 13 bankruptcy has begun its journey in Congress. Last week a committee in the House of Representatives voted the bill out and moved it to the full body for consideration.
HR 200 would substantially expand the powers of a debtor in Chapter 13 and give him or her the ability to do something that, up until now, has been sorely needed, but unavailable: Modify the terms of a mortgage secured by a primary residence over the objection of the lender. Presently this has been barred by a clause in the law (Section 1322(b)(2) of the federal Bankruptcy Code, for the legally-inclined), which was written into the law by lenders years ago. Given the current crisis, legislators see the necessity of removing it, in its current form.
With the change in the law — which is backed by President Obama and the Democratic majority — a home owner, in Chapter 13 could: 1) Reduce the interest rate on his or her loan to approximately the prevailing rate plus one, 2) Change the loan from a negative amortization or interest-only loan to one with positive amortization, 3) Possibly extend the term to as much as 40 years, and — most importantly — 4) Reduce the principal balance TO THE CURRENT VALUE OF THE HOME.
Reducing the balance of the loan to current value is a critical feature because it is well known that a key driver of the abandonment of houses to foreclosure is that houses bought, or refinanced, during the peak years (2005 to 2007) are “underwater” (have negative equity).
The other critical problem are the shortcomings of the current voluntary modification efforts of lenders. Securitization of a large number of the loans made during the peak period has compounded the problem. Such loans are virtually impossible to modify because they have been pooled into trusts for the benefit of a large and diffuse number of investors — there is no real owner to agree to a modification of the loan contract signed by the home owner.
Congress is only partially motivated by a desire to help the home owner in need. It recognizes the fact that until we stop the growing inventory of foreclosed homes going into the market, the nation will not see a resurgence of the real estate industry. Let’s keep our fingers crossed this gets passed — and soon! This will be a boon for distressed home owners in Maryland and DC where this law office practices.