One bill passed by the U.S. House of Representative's yesterday would relieve foreclosed borrowers of tax liability for deficiency balances forgiven by mortgage lenders. Another bill passed by a House committee would empower bankruptcy judges to make modifications to mortgages based on loan-to-value.
The U.S. House Judiciary Committee's Subcommittee on Commercial and Administrative Law Thursday reportedly passed H.R. 3609, a bill that would allow bankruptcy judges to modify the terms of a mortgage contract during bankruptcy proceedings.
Supporters of such change include the Center for Responsible Lending, which in recent testimony urged the committee to intervene and "tweak" Chapter 13 bankruptcy code to permit mortgage loan modifications as a means to forestall a national economic crisis through subprime foreclosures.
Currently, federal law makes a mortgage on a primary residence the only debt that a bankruptcy judge cannot modify -- even though mortgages for vacation homes and investment properties can be modified, according to the written testimony of the center's president, Eric Stein.
The center proposed that laws be changed to allow a bankruptcy judge to reduce the principal the borrower owes on the mortgage to match the home's current market value, as well as to modify the loan's interest rate. While the reduced principal balance would be treated as secured debt, the rest of the original principal would be treated as unsecured debt that would be given less priority for repayment and could be discharged, Stein said.
The group estimates $72.5 billion in equity will be preserved for borrowers with homes located near foreclosed properties because the move would help prevent 600,000 foreclosures.
The Mortgage Bankers Association, however, apparently does not back up the proposed changes and called for further examination of the bill, which will now be considered by the full House Judiciary Committee.
"Giving judges free rein to rewrite the terms of a mortgage would further destabilize the mortgage-backed securities market and will exacerbate the serious credit crunch that is currently hindering the ability of thousands of Americans to get an affordable mortgage," said Kurt Pfotenhauer, MBA senior vice president for government affairs and public policy, in an announcement. "The current legislation gives no guidance as to the proper parameters for judges to modify existing loan contracts."
Allowing judges full liberty to rewrite mortgage contracts and provide relief they deem appropriate would cast doubt on the value of the asset securing the mortgage, likely resulting in lenders and investors demanding a higher premium on mortgages in the form of higher fees, higher interest rate or a larger downpayment, the Washington, D.C.-based trade group said.
"The reason you only pay six percent on a mortgage loan, where another type of consumer loan may cost ten percent or more, is that the mortgage loan is secured by an asset -- the home," Pfotenhauer said. "When a judge can unilaterally reduce the amount that the lender can get when the home is sold, it devalues the asset securing the loan and the lender and investor will either not fund a loan, or will increase the cost of the loan. Either way, consumers are the ones who pay the price."
But the center argues that loan modification in bankruptcy does not increase the loss that will be taken by lenders and investors in foreclosure. The proposed changes would guarantee lenders the value of the property they took as collateral, providing a better deal than the lender would get at foreclosure.
"Lending experience during the fifteen years in which bankruptcy courts were modifying mortgage loans on primary residences belies some lenders' claim that allowing such modifications would negatively impact the cost or availability of credit," Stein said. "The claim is similarly belied by the past thirty years, continuing to the present, in courts have been modifying mortgage loans on family farms, investment properties, vacation homes and commercial real estate with no ill effects on those submarkets."
MBA additionally noted that H.R. 3609 removes the requirement of having bankruptcy debtors receive credit counseling.
The bankruptcy bill wasn't the only mortgage-related legislation to pass.
By a vote of 385-28, the House of Representatives Thursday passed H.R. 3648, which would extend the deductibility for mortgage insurance premiums for seven years and exclude discharges of debt on primary residences from gross income, MBA said in a separate announcement.
The bill, which appears to have President Bush's support, was unanimously approved by the House Committee on Ways and Means last week. It would eliminate income taxes on deficiency balances forgiven by a lender after a foreclosure on a primary residence but cost U.S. taxpayers around $1.4 billion over the next decade.
"I hope the Senate recognizes the importance of this legislation and moves quickly to get it to the President's desk," MBA Chairman John M. Robbins said in the announcement.
Congresswoman Stephanie Tubbs Jones was among the 385 representatives who voted in favor of the Mortgage Forgiveness Debt Relief Act.
"Generally, when people cannot afford the pay their mortgage, the last thing that they need is to have income added to their tax bill they never actually saw," Jones said in a written statement. "This legislation helps to reverse this arcane tax provision and will help us stem the tide of foreclosures throughout this country."