Bankruptcy Laws October 11, 2007Federal Issues CommitteeThe following is for study only and has NOT been approved by the Board of Directors.
Issue: The issue of including mortgages in bankruptcy proceedings was last strongly broached in the early 1990’s. At this time, NAR and C.A.R. were against the concept, specifically the cramdown provisions. However, in the early 1990’s, loans were predominantly fixed rate mortgages and ALT-A loans with exploding ARMS were not predominant on the market. Needless to say, times and mortgages have changed dramatically since the last time this issue was taken up by REALTORS®. Is it time for C.A.R. and/or NAR to revisit these issues considering the current market conditions? Action: Action is not required at thistime
Options: 1. Support 2. Oppose 3. Neutral 4. Not Real Estate Related 5. Recommend That NAR Research the Issue Further and Report Back Their Findings 6. Other
Status/Summary: On September 20, 2007, Congressman Miller (D-NC) introduced H.R. 3609, the Emergency Home Ownership and Mortgage Equity Protection Act of 2007. H.R. 3609 was referred to the House Judiciary Committee and currently has 14 cosponsors, including Reps. Lofgren, George Miller, Linda Sanchez, and Loretta Sanchez. H.R. 3609 would revise federal bankruptcy laws and allow the terms of mortgages to be included in bankruptcy filings.
The revisions would mean that a homeowner could include their mortgage, and the terms of that mortgage, in their bankruptcy proceedings and ask the judge to modify either the terms of the loan or even the overall principle of the loan.
The concept of modifyingthe principle of the loan is known as a “cramdown”. A cramdown is used when the value of a home is less than the outstanding principle of the loan. The overall mortgage is not eliminated; however, the judge can reduce the principle of the loan to what the market value of the house is currently at. The amount reduced on the original principle then becomes unsecured, which is a lower priority in bankruptcy courts, and would likely be discharged. The bankruptcy judge would have the option of reducing the principle of the loan as well as changing the terms of the loan, including the interest rate.On October 4, 2007, the Judiciary Subcommittee on Commercial and Administrative Law held their markup of H. R. 3609. Multiple amendments were offered, but none passed. Although no amendments passed, some issues that might be re-addressed as the bill moves towards full House consideration are putting a cap on the amount of principle allowed to be crammed down and making sure that the changes are not used as a mortgage tool and only as a last resort. H.R. 3609 is scheduled to be heard by the full Judiciary Committee later in October, but no date for full House consideration has been announced.In the Senate, two different bankruptcy bills have been introduced. On October 3, 2007 Sen. Durbin (D-IL) introduced S. 2136. S. 2136 is currently in the Senate Judiciary Committee with one (1) cosponsor. S. 2136 is similar to H.R. 3609 and would amend bankruptcy laws on Chapter 13 and allows for judges to cramdown loans.
Also on October 3, 2007 Sen. Specter (R-PA) introduced S. 2133. S. 2133 is currently in the Senate Judiciary Committee with no cosponsors. S. 2133 would amend bankruptcy laws and allow mortgages to be included in Chapter 13 filings, but would not allow for cramdowns. However, S. 2133 would allow for a bankruptcy judge to stop or delay an interest rate increase, roll back interest rates, and eliminate early prepayment or prepayment penalties. No date has been set yet for the Senate Judiciary Committee to hear either bill.These bankruptcy bills include complex issues and may require the help of outside expertise in order to fully get a grasp on all of the implications of these reforms. These issues are still very new, and all the information and ramifications of these reforms may not yet be known.Background: The issue of including mortgages in bankruptcy proceedings was last strongly broached in the early 1990’s. At this time, NAR and C.A.R. were against the concept, specifically the cramdown provisions. However, in the early 1990’s, loans were predominantly fixed rate mortgages and ALT-A loans with exploding ARMS were not predominant on the market. Needless to say, times and mortgages have changed dramatically since the last time this issue was taken up by REALTORS®.
Currently, mortgages on primary residences cannot be included in Chapter 13 bankruptcy proceedings. However, mortgages on second homes and investment homes are allowed to be included.In a bankruptcy proceeding a judge tries to determine what debts need to be paid, which can be reduced, what terms can be changed to help payoff debts, and if any debt should just be written off. Unsecured debts, such as credit cards, are lower on the priority list than a secured debt, such as a car payment. Mortgages would be a secured debt and therefore be higher on the priority list. The judge would be allowed to address the terms of the loan, the interest rates, and even theprinciple of the loan in an effort to find a way to create a payment plan so the filer could payoff their debts and emerge from bankruptcy.Pro: These changes to the bankruptcy laws could help address someof the issues of the subprime, Alt-A, and predatory lending markets. Homeowners facing exploding ARMS or loans with negative amortization have little recourse currently available to them as they fight to maintain their mortgages and keep their homes. Allowing mortgages into bankruptcy court could give these homeowners the potential to challenge some of these loans and give them an avenue to alter the terms of their loan and allow them to keep their home and continue to pay their mortgage.Additionally, it could encourage lenders to be more proactive in helping these struggling homeowners before the mortgage enters into bankruptcy court. If lenders are worried that thebankruptcy court decisions could harm them, they could face added incentive to work with the homeowner and find terms acceptable to both the lender and homeowner before the homeowner is forced to decide between foreclosure or including their mortgage in bankruptcy proceedings.Con: There are some fears with allowing mortgages to be included in bankruptcy procedures. First, if mortgages are allowed in bankruptcy procedures and are allowedto be reduced, their value as a security on the secondary market could be put at risk. If mortgage securities can be altered in court, then their value will decline and could increase instability in the secondary mortgage market. This could lead to a reduced secondary market, which would decrease the available capital for the mortgage market.Additionally, lenders will not be willing to take this increased risk on mortgages without offsets. This means that lenders could increase interest rates on all mortgages in order to add a layer of security in case large amounts of mortgages enter bankruptcy court and are reduced. These two changes will dry up already unstable capital for mortgages as well as possibly increase the costs for mortgages for every homeowner looking to obtain or refinance a mortgage.Finally, there is a question as to whether or not we want to leave these financial decisions in the hands of a bankruptcy judge. Are they the right people to make these dramatic financial decisions about loans, especially loans that are bundled and already sold on the secondary market? Do we want to givea bankruptcy judge the power of acting as the mortgage underwriter, the appraiser, and the judge over other debts and assets as well?Impact on REALTORS®: These reforms to bankruptcy law could impact REALTORS® thatare working with homeowners in their efforts to keep their house and/or avoid foreclosure. This would give homeowners another option, albeit a drastic and potentially adverse option, in fighting to retain their home.Additionally, it could add leverage to help REALTORS® and homeowners negotiate the terms of the mortgage with the lender and avoid having to go into bankruptcy or foreclosure altogether.
Additionally, it could impact REALTORS® by driving up interest rates and potentially decreasing the amount of capital in the market for mortgages, making it tougher for buyers to secure a mortgage; leading to more deals running into issues if the buyer is unable to secure a mortgage.Finally, there is a concern that REALTORS® support or opposition to these reforms could carry the risk of alienating group that we have a strong working relationship with and whom have traditionally supported our issues. This could include consumer groups, lenders, and the secondary mortgage market to name a few.NAR Policy: NAR currently has policy from the early 1990’s that opposes cramdowns. NAR anticipates that this issue may beaddressed at the November meetings. At this point, it is unknown whether NAR will revise their policy.C.A.R. Policy: C.A.R. currently has policy from the early 1990’s that opposes cramdowns.The issue of including mortgages in bankruptcy proceedings was last strongly broached in the early 1990’s. At this time, NAR and C.A.R. were against the concept, specifically the cramdown provisions. However, in the early 1990’s, loans were predominantly fixed rate mortgages and ALT-A loans with exploding ARMS were not predominant on the market. Needless to say, times and mortgages have changed dramatically since the last time this issue was taken up by REALTORS®. Is it time for C.A.R. and/or NAR to revisit these issues considering the current market conditions?