Should Congress reconsider legislation that would allow bankruptcy judges to cramdown first position purchase money mortgages on a Chapter 13 debtor’s primary residence?
Months ago, I addressed the initiative known as the Durbin Amendment proposed in the last legislative session that was ultimately defeated. This initiative proposed an amendment to the bankruptcy code that would allow congress to enable bankruptcy judges to write down or “cramdown” a debtor’s principal residence purchase money mortgage to the current fair market value of the real estate.
This is often referred to as judicial cramdown. This would allow for the purchase money mortgage in first position to be secured up to the current value of the real estate and the remaining balance of the mortgage obligation would be treated as a general unsecured debt through a debtor’s Chapter 13 plan.
Unfortunately, this initiative was defeated during the congressional session. However, as the foreclosure rates continue to rise while real estate values decline and government programs such as HAMP, the Home Affordable Modification Program, over-promise and under-deliver there are murmurs of another push to revisit judicial cramdown in Chapter 13 bankruptcy.
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So why should Congress revisit this potential solution and what concerns can be addressed the second time around in order to carry more support through Congress?
First, government programs such as the HAMP program continue to deliver false hope to homeowners and no real solutions to the key problem that most homeowners face: negative equity. This program often only prolongs an inevitable foreclosure. Often homeowners are told to make trial modification payments and all the while the servicer never issues a permanent modification.
The U.S. Treasury department statistics state that nearly half of the 1.3 million homeowners who enrolled in the Obama administration’s flagship mortgage relief trial modification program have fallen out of the program.
When homeowners have been paying trial payments and their request for a permanent modification is rejected, these borrowers are now out the money they paid in good faith thinking a permanent modification was coming.
The borrower is also up against a foreclosure sale date and has little money to move to new housing. The worst part about the trial modification payment program is that the servicing bank says you have to make three monthly trial modification payments.
However, this trial period often goes on for many more months and the homeowner is told by customer service to continue to make the trial payments and that the permanent modification is “still under review.”
The homeowner could have remained in the home during the foreclosure lawsuit for “free” and could have saved money in order to move.
First, one could argue that HAMP delays economic recovery through this process. It keeps homes that should enter the market as Real Estate Owned from doing so and thus delays liquidation and this delays economic recovery.
Second, HAMP does not address principal reductions or second mortgages, and the program does not have any teeth in it, so that lenders and their servicers must reduce principal or face sanctions from the government.
Homeowners in some cities in Florida have seen almost a 50 percent reduction in their real estate values.
To make it worthwhile for homeowners to continue to pay for the home, a mechanism for real principal reduction needs to be addressed by the government.
The forum for this is the bankruptcy court. Chapter 13 already provides for avoidance of certain junior or second mortgages on a debtor’s primary residence.
The new mortgage cramdown would be similar to the current vehicle cramdown that reduces the principal balance of the loan to the value of the car plus interest and pays the rest as a general unsecured debt through the Chapter 13 plan.
This is where the original initiative to cramdown irst position purchase money mortgages in Chapter 13 bankruptcy, under the Durbin Amendment, was derived from; however, this initiative did not pass.
Currently the state of the law is that you cannot cramdown a first position purchase money mortgage on a debtor’s principal residence.
If Congress reconsiders this initiative again, certain carve outs and exceptions need to be addressed and written into the code.
The banks lobbied hard against the first initiative because the concern is that the cost of financing will drastically increase because of the risk the banks must now build into the interest rate for any new loans made to purchase a home.
This is a cost that is ul- timately passed on to the homeowner, of course. But that borrower is also a taxpayer whose pockets have already been pilfered to rescue failing banks.
Cynthia A. Riddell, a Sarasota attorney whose practice primarily focuses on bankruptcy, real estate foreclosure, and short sales, can be reached at (941) 366-1300.