The Helping Families Save Their Homes Act authorizes bankruptcy courts to modify the terms of mortgages made on homeowners’ primary residences, a practice which is barred by current law. The bill would permit bankruptcy courts to restructure the debt on home mortgages by reducing the principal owed, extending repayment periods, reducing interest rates, and prohibiting, reducing, or delaying future interest rate increases. Bankruptcy law currently permits such restructuring only for vacation homes, family farms, and yachts. Under this bill, eligibility is limited to homeowners with mortgages originated before the enactment of the legislation who have received notice that a foreclosure may be commenced. The legislation restricts the situations in which bankruptcy judges can reduce – or “cram down” – the principal owed.
To be eligible for modification in bankruptcy, a mortgage holder must contact the lender regarding modification through the President’s Homeowner Affordability and Stability Plan – and consider such modification – at least 30 days before a bankruptcy case begins. If a bankruptcy court reduces a mortgage’s principal and the value of the home later rises, the lender is entitled to receive a portion of the net proceeds from sale of the property. The bill waives the current requirement for budget and credit counseling when homes are in foreclosure, protects homeowners from certain fees incurred while a bankruptcy is pending, and permits bankruptcy courts to wave penalties on homeowners who pay their mortgages in full ahead of schedule. The legislation allows the Federal Housing Authority (FHA) to pay insurance claims on FHA-insured mortgages that are modified in bankruptcy. The FHA is also authorized to carry out its own mortgage modification program.
The Helping Families Save Their Homes Act includes modifications to the Hope for Homeowners Act designed to increase participation in the program that are paid for with TARP funds. A separate provision provides safe harbor from legal liability to mortgage servicers that modify loans.
The bill permanently raises the amount of bank deposits that are insured by the Federal Deposit Insurance Company (FDIC) to $250,000.
The Middle-Class Position:
The 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 abusive mortgages with exorbitant interest rates. The federal government and the mortgage industry’s continued failure to address the subprime mortgage and 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 households. 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:
“It is important also to provide a backstop to protect those homeowners whose lenders cannot or will not agree to voluntarily modify their loans, either through the TARP initiative or otherwise. The best and only solution in these cases – provided the homeowner could sustain a market rate mortgage – is to lift the ban on judicial modifications, and allow a bankruptcy court to implement an economically rational solution that otherwise would be lost. [The bankruptcy provision] would immediately help stem the tide of foreclosures at zero cost to the U.S. taxpayer.” – Michael Calhoun, President and CEO, Center for Responsible Lending, January 13, 2009
“[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
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 the 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 current mortgages at risk of foreclosure, but bankruptcy itself is unpleasant, damaging credit and subjecting living expenses to court review.
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.
The act 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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