Change In the Bankruptcy Law: Good and Bad!

In a recent article on CNNMoney.com:

"One consumer group estimates that 600,000 foreclosures could be avoided over the next two years by making a simple change to the bankruptcy code...

The Center for Responsible Lending (CRL) is a nonprofit and nonpartisan research and policy organization that is dedicated to the protection of homeownership and family wealth. They do so by working to eliminate abusive financial practices. They refer to this change as a "tweak" in the bankruptcy law; a tweak in this case that would heavily impact homeowners facing foreclosure but one that would also stretch further and impact the mortgage-backed securities market.

But don't you think this change could have a de-stabilizing effect on the mortgage market?

More from the article:

"Under the current law, when a person files for Ch. 13 bankruptcy, judges cannot reduce mortgage debt owed on a person's primary residence, although they may modify mortgages on investment property or second homes.

Under the House bill, the bankruptcy judge would have the option of reducing what the homeowner owes the lender. Say a homeowner's property is worth less than what he owes. The judge could reduce the principal to match the home's current market value as well as reduce the loan's interest rate.

The rest of the original principal would then be treated as unsecured. That means it becomes a lower priority for repayment than the borrower's secured debt, such as the newly reduced principal on his home. Unsecured debts may be discharged."

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Posted Monday Oct 01

(10/01/07 10:11PM) — Jason Schweiger

It does not seem fair that they can modify investor homes and not primary residences. Good post.

(10/01/07 10:17PM) — Larry Bettag Illinois FHA Specialist

There are a lot of modifications and the implications are pretty severe. BK is not what it was.

(10/01/07 10:21PM) — Chris Giddings

Ricardo,

Like you, I have been watching the bill on this, and noticed the CNN report today.

It does bring up a tremendous amount of possibilities for homeowners, The first issue i see is the huge increase in bankruptcy filings. Thus damaging credit further for the homeowner. As it stands currently, The bankruptcy trustee has the authority to modify the existing debt on Investment properties, this without the approval of the lender. Interesting that many investors may not move forward in funding such a deal if they were fully aware of the potential for a lessor R.O.I.

Now, with the proposed legislation, One can only surmise lenders will make stricter regulations on future borrowers leading further to the the shortage of money to purchase and subsequently driving property values lower.

In it's own right the bill is a wonderful idea, saving the possible 600,000 homeowners but this also means 600,000 more bankruptcy filings and the same amount removed from the market for the next 10 years.

Do we really want to lead the American public down yet another path of credit devastation.

Chris Giddings

(10/01/07 10:38PM) — Ricardo Bueno - Mortgage Planner

From my blog at www.industry-report.com

My Opinion:

The benefit to the home owner here is obvious. If you own more than your property is worth, the courts could adjust your principal balance to bring it down to it's current market level. This would lower one's payment.

To the end-investor driving the capital markets, knowing that the courts have control over the lender on what is owed on a property, can have a negative effect on a borrower's perceived risk thereby changing their valuation; bond prices move down and interest rates rise.

(10/01/07 11:56PM) — Barry Shapiro

Regardless of the laws -- someone will figure out a way to get a "free lunch"... Thanks for the insightful blog, Ricardo!

(10/02/07 12:52AM) — Kate Bourland; Redding Mortgage, Loss Mitigation, Money Merge Accounts

Funny that you should blog on this topic today. I've been thinking about this all day. If Chapter 13 can keep someone in their home, I'm not sure that it's bad.

Certainly it wouldn't be the first choice, but foreclosure punishes the buyer and buries them in the process due to the tax burden from forgiven debt AND the trashing of the credit score.

If your credit score is going to be trashed anyway, why not keep your home and be able to rebuild in the future. It seems to me that this scenario would lower inventory levels and could bring back the market more quickly. Not sure I agree that interest rates would rise. This is a more global market than it's ever been before and the rules and norms are changing.

I also understand that someone can buy their way out of a Chapter 13 bankruptsy. It's difficult and I don't know much about it.

(10/02/07 01:18AM) — Ricardo Bueno - Mortgage Planner

Jason: you raise a good point by saying that you "don't think is fair." How do you think the end-investor on Wall Street (the one driving the mortgage-backed securities market) would feel about their investment? I'm sure they would consider the borrower to be a higher risk at this point. Don't you?

(10/02/07 01:25AM) — Ricardo Bueno - Mortgage Planner

Larry: thanks for stopping by! It certainly is not (BK).

Chris: thank you for stopping by and sharing your insights. It appears you are on board with the point that I was driving home.

If this change were to take place I'm sure we'd see stricter lending guidelines as the end-investor would not be too pleased with the fact that a loan could be modified without the lender's consent. This has a detrimental effect on their return on investment.

This is why I allude to the fact that such change could negatively impact the market landscape; it could very well de-stabilize the mortgage market. Sure those are strong words but let's not forget that we suffered a credit crisis because the end-investors don't want to buy mortgages on the secondary market. We're supposed to make loans sale-able so as to establish liquidity in the secondary market. Certainly allowing a loan to be modified without lender consent makes these loans less sale-able.

(10/02/07 01:29AM) — Ricardo Bueno - Mortgage Planner

Barry: why yes of course! How true this is! And we of all people know what this is like. How often are we asked to lower our commissions more and more? Surely we've all experienced this to an extent.