House Approves Bankruptcy Loan Modification Bill
A bill allowing bankruptcy judges to lower mortgage payments for struggling homeowners was approved Thursday and may be sent to Senate in the next few weeks. Prior to the approval, it faced strong opposition from major banks and lenders, who insisted that it would drive up housing costs in the long run.
The approval came after reports that mortgage defaults reached an all-time high of 5.4 million last year. According to a Mortgage Bankers Association survey, almost 12% of homeowners by the end of 2008 were either behind on their mortgages or already in foreclosure.
The bill, which forms part of President Obama’s program for rescuing the housing sector, would allow judges to reduce the principal and interest rates on such mortgages. A previous bill had already given them authority to modify car loans and student loans, but clearly precluded mortgage modification.
According to proponents of the bill, this would urge banks to work out better arrangements with troubled borrowers as an alternative to bankruptcy. Critics claim, however, that the increase in bankruptcy filings will hike up mortgage rates and be more detrimental in the long run.
Housing Secretary Shaun Donovan worked out a compromise limiting the bankruptcy option to homeowners who have previously sought other means of assistance. To qualify for bankruptcy loan modification, a borrower must first approach the lender and actively seek other solutions before resorting to bankruptcy. A wait time of 30 days will be imposed, giving lenders enough time to draw up alternative offers.
The compromise would also allow judges to study each case to see if the lenders’ terms match those in the housing plan, which is a debt-to-income (DTI) ratio of 31%. If the borrower receives a loan modification but is still over the DTI limit, he or she can still apply for Chapter 13 bankruptcy.
To minimize the risk, the court will require a good-faith statement from borrowers, which will include proper documentation and a plan for repaying the loan. This keeps the option open to people who qualified for their loans without complete documentation, but retains a measure of security for both the courts and the lenders.
Lenders will also get cuts from any homes sold while the bankruptcy plan is in effect. Borrowers who sell their homes within one year of modification will have to give 90% of the proceeds to the lender, 70% if they sell within two years, 50% after three years, and an additional 10% for each year after the fifth.
California Representative Ellen Tauscher, who led movements to get the bill revised, adds that while the bill has its flaws, it has exceeded most expectations and ensures that bankruptcy will be a homeowner’s last choice.
Also part of the bill is an incentive for lenders who follow the Hope for Homeowners loan modification program. Participating banks and credit unions would be given a permanent increase in federal insurance from $100,000 to $250,000.
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