Federal bankruptcy courts currently offer only scant relief to homeowners who can't afford to pay their mortgages. That could change, if supporters of legislation that would allow bankruptcy judges to modify mortgages can muster enough votes in Congress to override a threatened presidential veto.Giving bankruptcy courts the authority to modify home loans would be a palatable way to accommodate both borrowers and lenders, says Jack Williams, a bankruptcy professor at the Georgia State University College of Law. Borrowers would "get to keep a major asset with significant upside potential" and avoid the emotional wound of losing their homes, while lenders would be placed in "a position based on the fair market value of the property," which would be better than a foreclosure, Williams says.Currently, bankruptcy affords "very limited protection to a (homeowner) who has a financial problem with a home-mortgage company," Williams says. Filing Chapter 13 bankruptcy, which is characterized by a debt-repayment plan, can spread out prior delinquent payments over a number of months or years in the future; however, no bankruptcy proceeding can modify the terms of an existing home loan on a principal residence.The exception for residential mortgages dates back to 1978, when the bankruptcy code was written, says Williams, who is also a scholar-in-residence at the American Bankruptcy Institute, or ABI, a nonpartisan organization that researches issues related to insolvency. That exception makes home-loan lenders a favored class of creditors and originally was intended to encourage mortgage lending.Thirty years later, after rapid and radical innovation in home loans and mortgage lending, that purpose may no longer make sense as good public policy, says Susanne M. Robicsek, a bankruptcy attorney in Charlotte, N.C. "Historically, the argument was that they didn't want to discourage banks from making loans to consumers. The types of loans have changed immensely, and we now find ourselves in a new lending environment that has led to a crisis that can't be solved," she says.The bankruptcy bills that have been introduced in Congress would limit relief to homeowners who didn't earn enough income to afford mortgage payments, had a subprime or nontraditional loan or faced imminent foreclosure. Bankruptcy judges would be required to set commercially reasonable interest rates on modified mortgages and not reduce loan balances to less than the market value of the property.Critics have suggested that more flexible bankruptcy laws would encourage homeowners to file bankruptcy solely to escape mortgage payments that were affordable but that they believed to be onerous.The argument that mortgage modification would spur even more bankruptcies was raised and refuted by Rich Leonard, a bankruptcy judge in North Carolina. In testimony before a congressional committee, Leonard noted that the precedents of existing bankruptcy cases already "sharply curtailed" judges' discretion with respect to modifications of other types of debt. "The idea that we would -- or could -- somehow willy-nilly give everyone a 40-year mortgage at 2 percent interest is ludicrous," he told the committee.The Mortgage Bankers Association has insisted that allowing bankruptcy judges to modify the interest rate or principal on owner-occupant residential mortgages would unleash a number of woes. On the association's Web site it states that the House version of the bill would increase the cost of all mortgages, increase foreclosures, hinder refinancing of existing loans and harm federal loan programs.The MBA also has claimed that mortgage modifications would create more uncertainty about home values, which would result in more risk for lenders and, thus, higher closing costs and interest rates for homebuyers.Williams scoffs at such concerns. "The argument that interest rates would go up doesn't make any sense, and (the MBA has) never offered any proof to support it," he says.The House Judiciary Committee passed a version of the bankruptcy bill in December. The companion bill has been stalled for procedural reasons in the Senate, but Sen. Dick Durbin, D-Ill., the bill's chief supporter, has vowed not to drop the effort.However, President Bush has declared his opposition to allowing bankruptcy judges to modify the terms of owner-occupant home loans. In a policy statement, the administration said changing the bankruptcy code in this way would "undermine existing contracts, leading to contraction in mortgage-credit availability and affordability" and "likely prolong the time it will take the market to recover from the current downturn."X...X...XThe benchmark 30-year fixed-rate mortgage fell 41 basis points, to 5.98 percent, according to the Bankrate.com national survey of large lenders. A basis point is one-hundredth of 1 percentage point. The mortgages in this week's survey had an average total of 0.38 discount and origination points. One year ago, the mortgage index was 6.19 percent; four weeks ago, it was 6.37 percent.The benchmark 15-year fixed-rate mortgage fell 39 basis points, to 5.46 percent. The benchmark 5/1 adjustable-rate mortgage skyrocketed for the second week in a row, rising 23 basis points, to 6.44 percent. The 5/1 ARM has risen 72 basis points in two weeks. The benchmark 30-year fixed jumbo loan fell 17 basis points, to 7.43 percent.(Distributed by Scripps Howard News Service. Reach Marcie Geffner at editors(at)bankrate.com.)
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