News Columns & Blogs

Mortgages: Banks keep control of terms

In a vote that demonstrates the veto power exercised by Wall Street on government policy, the Senate rejected a measure that would have allowed bankruptcy judges to modify the terms of mortgages to help distressed homeowners avoid foreclosure. The legislation would have enabled bankruptcy courts to lower the outstanding principal as well as interest rates on some home loans on primary residences for debtors filing under Chapter 13 of the bankruptcy code.Bankruptcy judges are allowed to make such changes for second homes or investment real estate, but not for primary residences. Stripped of the mortgage cramdown “stick,” all that remains in President Obama’s “Homeowner Affordability and Stability Plan,” which the Senate is expected to pass this week, is a series of “carrots” for the banks.For example, one provision inserted into the bill at the bidding of the banks will reduce a proposed premium owed by the banks to the Federal Deposit Insurance Corp. in return for hundreds of billions of dollars in FDIC guarantees on the banks’ bond issuances by more than 50 percent. This will save the banks an estimated $7.7 billion.Majority Whip Richard Durbin, of Illinois, who was the measure’s chief champion, declared that banks “are still the most powerful lobby on Capitol Hill. And they frankly own the place.” Many of these banks, including Wells Fargo, Bank of America and JPMorgan Chase, are recipients of taxpayer-funded bailout money. Essentially, they are using taxpayers’ money to fight against a public policy that would have helped many taxpayers — especially taxpayers in Florida. And the Senate let them win.The stick is now held firmly by the lender, who may try to compel a borrower with a short sale offer to settle up out of pocket at closing for the mortgage balance that the sale price will not cover. Typically this is accomplished by compelling the borrower to sign a new note or reaffirm the existing one.So what is a homeowner to do? Bankruptcy may still be an avenue for some homeowners having difficulty achieving a satisfactory workout such as a short sale or a deed in lieu of foreclosure. Once the bankruptcy petition is filed by the debtor/borrower, the automatic stay is imposed on the debtor’s creditors and their collection activities must cease unless they get permission from the court to proceed. Debtors in bankruptcy may opt to surrender their homes even if there are short sale offers on the table. The debtor may stay in the home without making mortgage payments until the deed transfers out of their name.The underlying personal liability for the debts is discharged as to the debtor in bankruptcy and if the lender attempts to collect against the borrower personally in any way, it violates the law. If the lender chooses to continue the foreclosure, it must wait until the bankruptcy trustee determines that there is no equity in the property for distribution to other creditors or it must request permission from the bankruptcy court to lift the automatic stay. Once the stay is lifted, the lender must take the matter back to state court to complete the foreclosure. The lender may not obtain any deficiency judgment against the bankrupt borrower.But continuing the foreclosure in state court after the borrower files bankruptcy may not be the most prudent option for lenders if there is already a short sale offer on the table and a willing buyer. The Twelfth Judicial Circuit seems to be “ground zero” for foreclosure filings in Florida, and it is difficult, time consuming and costly for the secured creditor to complete the foreclosure process.Even if the lender does complete the foreclosure process, there are inherent problems when a previously occupied property lies vacant. Vandalism, squatters, systemic problems, code and homeowners association violations are among them. It is not unheard of for the homeowners themselves to vandalize or strip the property before leaving it for good. There is also the possibility that health hazards may arise and of potential liability for personal injury suits should unauthorized persons enter the property.This may give homeowners with pending short sale offers some additional leverage to convince lenders to accept the sale of the property even after a bankruptcy filing. The bank is unlikely to get a higher and better offer in the short term and holding the property for the longer term could result in greatly increased costs to the lender. Completing the sale will allow the lender to avoid the problems previously mentioned with respect to vacant property. Furthermore, the homeowner will be able to remain in the home until closing and will be much more likely to tend to it as a regular seller would, knowing that it is to be purchased and not just sold at auction. The most important benefit to the borrower/homeowner is that he or she already has the benefit of the bankruptcy discharge and cannot be coerced into making any additional payments on any notes. Accordingly, it benefits both the lender and the borrower to complete the short sale, even after the bankruptcy is filed.Cynthia A. Riddell, an attorney whose practice primarily focuses on real estate foreclosure, short sale and bankruptcy issues, can be reached at