Real Estate Finance Committee
Federal Issues Committee
(The following is for study only and has NOT been approved by the Board
Issue: The issue of including primary mortgages in
bankruptcy proceedings was last addressed in the early 1990’s. At
that time, NAR and C.A.R. were against the concept, specifically the
cramdown provisions allowing bankruptcy court judges to reduce mortgage
principal. However, in the early 1990’s, loans were predominantly
fixed rate mortgages, and ALT-A and subprime loans with exploding interest
rates were not prevalent in the market. Times and mortgages have
changed dramatically since the last time this issue was taken up by
REALTORS®. Is it time for C.A.R. to revisit this issues considering
the current market conditions?
Action is not required at this time; however, this issue may be included in
legislation as early as January including the next economic stimulus
1. Support giving bankruptcy court judges the authority to modify the
first-mortgage on a principal residence.
2. Take no action and continue to oppose giving bankruptcy court
judges the authority to modify a first-mortgage on a principal
3. Take a neutral position and monitor and report on the issue as it
4. Support giving bankruptcy court judges the authority to modify a
first-mortgage on a principal residence with restrictions and/or
Senator Durbin (D-IL) has introduced S. 61, the Helping Families Save Their
Homes in Bankruptcy Act. This bill would allow bankruptcy judges to
modify mortgage loans on a debtor’s principal residence, so that primary
mortgages are treated the same as vacation homes and family farms.
This would allow judges to modify the terms of the loan, including mortgage
principal reduction, interest rates, prepayment penalty and length of the
loan. Representative Conyers (D-MI) has introduced a companion bill
in the House. California Senators Feinstein and Boxer have already
signed onto the Durbin bill as cosponsors.
The concept of reducing the principal of the loan is known as a
“cramdown”. A cramdown is used when the value of a home is less than
the outstanding principal of the loan. The overall mortgage is not
eliminated; however, the judge can reduce the principal of the loan to what
the market value of the house is currently at. The amount reduced on
the original principal 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 principal of the loan as well
as changing the terms of the loan, including the interest rate.
Similar legislation in the past has been vehemently opposed to by the
lending community. Recently though, Citibank has broken ranks with
the lending community to support a stripped down bankruptcy reform
proposal. Citibank has agreed to support a bankruptcy proposal
allowing for cramdowns and in return was promised that the legislation
• Require borrowers to contact their lender to seek modification at
least 10 days before filing for protection.
• Loans would have to have been originated before the bills enactment
Many in the lending community are appalled by Citibank’s unilateral
movement to secure a deal. Additionally, many think Citibank should
have asked for other concessions such as:
• A sunset date.
• Its application to only nontraditional mortgages, such as Alt-A and
• A longer notification period than 10 days.
While the lending community is upset with Citibank’s compromise, their
statements of missed negotiating opportunities would suggest they are open
to the idea of giving judges authority to do cramdowns if it came with
certain restraints. This may be in response to the overwhelming
democratic majority’s and president-elect Obama’s calls for quick passage
of this legislation.
The issue of including primary mortgages in bankruptcy proceedings was last
addressed in the early 1990’s. At that time, NAR and C.A.R. were
against the concept, specifically the cramdown provisions. Home loans
were not viewed as a threat to a family’s financial wellbeing because it
was a steady non-changing payment.
Currently, first 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 the
principal 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 some of the issues of the subprime, Alt-A, predatory lending,
homeowners upside down on their loans, and help stem the tide of
foreclosures. Homeowners have little recourse currently available to
them as they fight to maintain their mortgages and keep their homes.
Many homeowners have found that their lenders are unable or unwilling to do
a loan modification and many loan modifications being done are having
little to no effect on actually reducing the monthly costs for a
homeowner. A recent study has shown that over 50 percent of workout
loans re-default after six months. 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 about a bankruptcy court decision, 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 bankruptcy.
There are some fear who allowing mortgages to be included in bankruptcy
procedures. First, if mortgages are allowed in bankruptcy procedures
and their principal allowed to be reduced, their value as a security on the
secondary market could be put at risk. This could lead to a reduced
secondary market, which would decrease the available capital for the
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 could dry up an already unstable supply of 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 give a 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® that are working with homeowners in their efforts to
keep their homes 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 currently has policy from the early 1990’s that opposes
cramdowns. At this point, NAR seems satisfied to not alter their
policy, but also not object to bankruptcy reform being included in a
C.A.R. Policy: C.A.R. currently has policy from the
early 1990’s that opposes cramdowns.
Should C.A.R. change its policy on the issue of giving bankruptcy court
judges authority to change the loan terms of a first-mortgage on a