Revising Bankruptcy Laws for Principal Residences is Good for Business

Facts

Historically, our bankruptcy laws have permitted court approved adaptation of every type of debt obligation except for mortgages secured by single-family principal residences.

Mortgages and mortgage terms are not modified by bankruptcy judges. Debtors propose the modifications, if the modifications are acceptable lenders agree, and then the bankruptcy judge approves the modification if it meets the requirements set forth in the Bankruptcy Code.

Mortgage servicers generate revenue on defaulted mortgages for single-family principal residences by assessing fees and penalties.

Old Assumptions

Mortgage lenders claimed that if their losses on principal residences were limited, then they would pass on the savings to home buyers in the form of lower interest rates. Their rational was that this would encourage homeownership.

Allowing the reduction of the principal on the mortgage for a single-family principal residence would make mortgage backed securities less valuable.

New Assumptions

Mortgage lenders often lose 40-50% of the value of their loan through foreclosure.

If Bankruptcy laws were revised to allow debtors on single-family principal residences to re-negotiate the mortgage principal and terms with their lenders then lenders would have one more tool to use in their efforts to manage risks, reduce their losses from foreclosures, and maximize overall return on investments.

Conclusion

There is no empirical evidence to show that:

• Existing practices generate lower interest rates,
• Encourage home ownership, or that
• A reduction of principal would make mortgage backed securities less valuable.

 If the new assumptions prove to be valid then:

• Mortgage lenders and investors in mortgage backed securities will see a reduction in their losses and improvements in the value of their assets.
• Mortgages servicers earnings from fees assessed on defaulted mortgages would be diminished by this change in the Bankruptcy Code.

Recommendation

The newly proposed legislation to allow debtors to re-notiate their mortgages on single-family principal residences would provide a much needed alternative that would reduce lenders' losses, allow homeowners to stay in their homes, and help stabilize the housing market. It deserves no less than a fair and impartial review and a straight up vote on its merits.