The debate is on about a new law that would give bankruptcy judges the power to rewrite mortgages. Like a spelling bee, the “teams” are lining up on both sides. As a bankruptcy attorney in Indiana, I’ve been following this important issue for the past year, awaiting the U.S. Senate vote that could come within days.
The way bankruptcy proceedings work now, judges are restricted from dealing with mortgages and foreclosures. This restriction goes back to the l970’s, and it was put in place to encourage banks to lend to more new home buyers.
Advocates of the proposed new plan, mostly Democrats, believe the change in bankruptcy law could protect as many as 600,000 homeowners from foreclosure on their homes. Senator Richard Durbin is quoted in the Washington Post: “We should be giving families every reasonable tool to ensure they can keep a roof over their heads.” Support for the measure is coming from labor unions, civil rights organizations, and even AARP.
On the opposing side are many of the large banks, the American Banking Association, the Financial Services Roundtable, and the Mortgage Bankers Association. One of many letters addressed to the senate explains the reason: “The legislation would have a very negative impact in the financial markets….and would greatly increase the uncertainty that already exists.”
To put all of this into terms of the people with whom I’m involved every working day, imagine a family (I’ll call them Smiths) that purchased a home with almost no down payment, using a combination of a first and a second mortgage. Two months after that home purchase, the husband was laid off, with the wife’s pay cut almost in half due to the economy. To top it all off, they have some significant medical bills for their daughter. The Smiths’ two cars are being financed, and they’ve built up quite a bit of credit card debt.
If the new bankruptcy law is enacted, the Smiths will be able to file a Chapter 13 bankruptcy. Their second mortgage could be totally removed (this can happen under current law, too), and their first mortgage reduced in size to reflect the actually market value of their home, which is substantially less than what they originally paid for it. The interest rate could be cut by the bankruptcy court from 6 1/2% down to, say, 2 1/2%, and their payment period could be extended as long as forty years. The normal process of Chapter 13 would then address the credit card loans, and the Smiths could have a chance at being debt-free in five years.
Now, might things have been better for all concerned – the banks, the investors in mortgage-backed securities, the family, the realtor, the mortgage broker, etc. – had matters never reached this point? Of course! But….here they are! The idea is to find the best possible way to turn things around.
The U.S. bankruptcy law was created to offer a fresh financial start to responsible citizens who have fallen upon hard times. If the new mortgage modification bankruptcy law passes in the Senate and is signed into law, bankruptcy will cast a much broader safety net for the Smiths and hundreds and thousands like them!