In a recent post, we discussed how President Obama had proposed the “Mortgage Modification Bill” as part of his stimulus package. This Bill would allow bankruptcy judges to save hundreds of thousands of homeowners from foreclosure.
Though the Bill passed in the House of Representatives, it was defeated last week in the Senate. Many blame the defeat on the banks, which threatened that the Bill’s passage would cause the lending industry to go out of business. Proponents of the Bill spent weeks negotiating with the banks and even offered up a substantially narrowed version of the Bill, but the banks refused to budge.
This defeat is a travesty for homeowners, who will continue to be required to pay off their entire mortgage – even though the value of their homes has declined tremendously.
In reality, the relief proposed by the Bill was not an extraordinary measure. To illustrate, if you file for Chapter 13 bankruptcy, many personal property liens (such as car loans) only exist as a secured claim to the extent of the value of the underlying asset (i.e., what the car is worth). What this essentially means is that you’ll only need to repay your lender the amount that, for example, your car is worth at the time you filed for bankruptcy. If the car’s value has declined and is worth much less than the amount of the loan, often the lender can only hope to recover a small percentage of the balance. This is the case with most liens – except for mortgages secured by the debtor’s residence. The debtor is required to pay back the entire amount of the mortgage, regardless of what the value of his or her house is at the time of the bankruptcy filing. If the value of the home has declined, the lender can repossess the house AND still demand that the balance of the mortgage loan be paid in full. The relief proposed in the Bill simply sought to bring the law concerning liens on mortgages up to par with the law concerning liens on other types of property.
Contrary to the banks’ protests, the Bill would not have meant the end of the lending industry. Most banks do not hold onto the loans they make. Rather, they sell them off to institutional investors, and collect the service fees from this transaction for profit. The banks therefore rid themselves of any lending risk, and even manage to turn a profit.
The institutional investors would not have fared badly either if the Bill had passed. At the very least, they would still have been able to collect the mortgage in the amount that the house is worth. Instead, the only way these investors will likely see any repayment is if they foreclose on the house, sell it, and keep the proceeds. These proceeds could be worth even less than the value of the house, since the investors will have to pay tens of thousands of dollars in foreclosure and resale costs. And that’s assuming that they can resell the house! In this market, the house could very well remain unsold, leaving the investors with an empty house.