Tuesday, February 17, 2009

Opposition and Support for Bankruptcy Reform

Who's supporting Bankruptcy reform?

U.S. Representative Steve Cohen (D-Memphis, Tenn), chair of the House Judiciary Committee's sub-committee on commercial and administrative law is supporting bankruptcy reform. Bankruptcy filings in the state of Tennessee have climbed from 17,104 in 2007 to 18,841 in 2008.

David Kennedy, U.S. Chief Bankruptcy judge for the U.S. Bankruptcy Court in West Tennessee is also supporting wholesale changes to the U.S. Bankruptcy code. Kennedy and many other bankruptcy judges and trustees are recommending targeted reform of the massive 2005 amendment that overhauled the U.S. Bankruptcy law.

H.R. 200 and its Senate companion bill, S 61, would allow bankruptcy judges the power to modify home loans - a power they do not have when it comes to the primary home of a debtor. Current law allows them to modify the mortgage for a vacation home, commercial properties and other corporate debt, but not a primary home. The proposed legislation, as written, has a provision that provides lenders a equity share in the home if the homeowner sells the home within five years of the bankruptcy. *
I personally believe this clause should be removed from the bill. With the economy in turmoil, many Americans may be forced to relocate to different parts of the country or the world in order to remain employed. Equity stripping, in any form should be abolished. Predatory lending practices should not be encouraged by state or federal legislators.

Volunteer lender modification programs are not successful in part because mortgage servicers are not that interested in making volunteer modification programs work.

George Stevenson, a chapter 13 bankruptcy trustee, stated that government intervention may be the only way to provide relief to homeowners who are having difficulty getting back on their feet.

Meanwhile, the Mortgage Bankers Association of Washington and other major financial institutions claim that HR 200 would be a disaster for consumers and that modifications from the bench will further destabilize banks who are already struggling to stay alive.

But financial advisers and other consumer advocates applaud the bill calling it a badly needed move to stem the avalanche of foreclosures that are destabilizing the housing market. Best of all, it doesn't cost taxpayers a dime.

The omnibus bill would also contain other anti-foreclosure measures, including one that allows lenders to modify securitized loans without facing legal challenges from bondholders.

The banking industry claims that allowing judges to modify loans will lead to higher rates, fees and and down payments for all borrowers going forward. Not true, claim financial advisers, bankruptcy experts and real estate professionals.

Despite the threats and hand wringing by mortgage banks, consumer and political support for the proposed legislation is growing.

The lending industry has nicknamed the legislation "the cramdown legislation." Proponents ask, why do we call something that is aimed at keeping people in their homes "cramdown legislation" when the last time we modified bankruptcy laws it was called "consumer protection"?

Tony Proctor, a CFP at Proctor Financial in Mass., who manages a portfolio of $190 million counsels clients to do whatever they have to do to make sure they have a home to live in. He believes that lenders in the future are going to discount the problems they see on people's credit reports during this time frame. In fact, he recommended that Congress amend the bill to ensure that any credit blemishes that have occurred during this recession would be wiped off credit reports within three years.

Many Conservatives disagree. "Fundamentally, strip-down is a poor "fit" for the problem of rising foreclosure rates. Its benefits would fall disproportionately to those who can afford their mortgage payments and do not need relief, while those whose homes are at risk would typically obtain only temporary relief at a great personal cost. The result would be to impose enormous expenses on mortgage and consumer lenders—at a time when doing so would be destabilizing and counterpro­ductive—in exchange for extremely limited benefits for vulnerable homeowners." says Andrew Grossman, of the Heritage Foundation. http://www.heritage.org/Research/LegalIssues/bg2242.cfm

But Grossman neglects to mention that many of the lenders who are voluntarily participating in existing loan modification programs are insisting that borrowers sign documents that provide the lender with an equity share in the property. Many lenders also pay their modification employees a commission for securing a higher interest rate from distressed borrowers than they would pay if an attorney or a judge modified the loan. In other words, the lenders are more interested in maintaining a profit than they are in re-structuring a loan that will ultimately allow a homeowner to remain in the home.

Grossman also discusses the negative effects bankruptcy can have on an individuals credit profile. Ahem. Foreclosures are also reported on credit reports for 7 years. In addition, borrowers can lose all of their equity or find themselves still owing the lender money after the foreclosure is completed.

Distressed homeowners should seek the counsel of a competent attorney before agreeing to a loan modification, foreclosure or bankruptcy. For those who are destitute, there are a number of non-profits who specialize in bankruptcy and foreclosure counseling.

Where should we draw the line as consumers? First, the majority of states have passed legislation that allow lenders to impose pre-pay penalties on loans for a certain number of years. There are no pre-pay penalties on Fannie Mae, Freddie Mac, FHA, or VA loans.

In order to market pre-pays, lenders tell borrowers that they will receive a lower interest rate if they accept a prepay penalty. That may be so. But loans with pre-pay penalties pay a bigger yield to spread premium than regular Fannie Mae loans. So, a number of originators are motivated to sell loan products with pre-pays in order to make a larger profit on the loan.

Some may ask, what's the harm in that? We live in a capitalist society where cash is king - sure, there's some risk...

Indeed, there is risk. What happens if the homeowner is forced to relocate in order to keep his/her job or a family member has a medical emergency? The average hard pre-pay penalty can strip $6,000 or more from the home owner's equity. (Pre-pay penalties are a form of equity stripping and are considered in many circles a form of predatory lending).

Prepay penalties should be abolished to protect a citizen's right to relocate or sell a home in the event of a job relocation or medical emergency.

It is estimated that 47 million Americans are currently without medical insurance and that up to 80% of bankruptcies filed are caused by medical emergencies, not misuse of consumer credit.

In modification proceedings, many lenders ask distressed homeowners to sign over a portion of their equity in order to modify the loan. Remember, the homeowners who are modifying loans in order to keep their homes have to re-pay every penny of their missed payments -- so why should they be forced to sign over a portion of their equity to a lender in order to keep their home?

No matter how you slice it, lenders appear to be hell-bent to strip homeowners of a portion of their equity in order to ensure that they receive a larger profit for the loan if the borrower is forced to sell the property to protect his/her credit.

Let's step outside the box for a minute. What could be done to protect lenders and borrowers and provide additional stability to the housing market?

What if FHA and other government residential loan programs included a mortgage insurance policy that covers lenders and homeowners in the event a borrower defaults on the loan? (The insurance policy can make payments on behalf of the borrower for a set period of time, let's say, 6 to 12 months).

If all borrowers, regardless of their credit profile share a portion of the risk, lenders can continue to provide borrowers from all walks of life with low interest, low fee and low down payment mortgages. In addition, homeowners will have limited protection from foreclosure if they have a medical emergency or period of unemployment from economic downturns.
Under this scenario, both lenders and homeowners are secure in the knowledge that they are covered for a certain period of time if a borrower loses a job or has a serious medical condition. This isn't a freebie - it's an insurance policy that protects homeowners and lenders from foreclosure for a pre-determined period of time.

Congress could also require credit reporting agencies to drop bankruptcies, foreclosures and other credit blemishes from reports after three years for individuals who have been harmed by the current recession.

Finally, stop charging low income borrowers higher interest rates. In order to provide opportunities for home ownership, FHA and other government loan programs can provide low income borrowers with affordable fixed rate loans that are based on the borrower's ability to re-pay the loan, not credit scores.

After all, many of the families who are currently in crisis have maintained unblemished credit reports until now.

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