The Center for Responsible Lending is advocating a change to bankruptcy laws that would allow bankruptcy judges the ability to rewrite mortgage terms. The Center's position appears even more necessary in light of loan servicers' inability to permanently modify mortgages under the federal Home Affordable Modification Program.
Rewriting bankruptcy law to provide bankruptcy judges discretion to unilaterally impose revised mortgage terms is not a revolutionary idea. Bankruptcy judges can rewrite debtors' terms on many secured loans, most notably car loans. Due to lenders' powerful lobbying efforts, when Congress enacted the Bankruptcy Code in 1978, an exception was inserted into 11 U.S.C. section 1322(b)(2) that prevented bankruptcy judges from modifying first mortgages. Thus, even if a home is worth significantly less than the mortgage amount, the bankruptcy judge cannot revise the principle to the fair market value. The judge cannot affect the monthly payment either.
Ideally, providing bankruptcy judges the power to revise mortgage principal and montly payments would be unnecessary. The Home Affordable Modification Program was supposed to make it substantially easier for borrowers to work out loan modifications with lenders. However, while the Program has spurred 650,000 trial modifications, few have been converted into new permanent mortgages.
Extending bankruptcy judges' powers would provide borrowers a last, but potentially very effective, resort to stay in their homes if their lenders and servicers are unresponsive. Unless the Home Affordable Modification Program is more successful, Congress should take a look at following the Center for Responsible Lending's recommendation.
