A bipartisan group of Representatives will offer an amendment to H.R. 4173 to allow bankruptcy judges to modify the loans of homeowners in a Chapter 13 Bankruptcy.  This amendment is very similar to H.R. 1106, the bill that went down to defeat last spring.

If passed, many homeowners will be able to keep their homes by filing a Chapter 13 Bankruptcy.  The Judge will be able to change the terms of the loans on the house by adjusting the interest rate, the length of the loan, and even the principal owed.

The Government’s voluntary mortgage modification programs have been a dismal failure. What is needed is this unbiased look at the situation with the teeth to force lenders to do something.

Although, simply bringing an amendment to an existing bill is a long way from passage, it does give hope to homeowners fighting to save their homes.

It’s estimated that a cramdown law could reduce foreclosures by 20 percent. It would cut through red tape by forcing reasonable compromises in bankruptcy courts, which can already modify mortgages on second homes and yachts. Most important, it would provide that all-important stick: Modify more mortgages, or a judge will do it for you.

Certainly, the experience of my clients supports the national numbers.  While clients may be offered trial modifications (send us money while we shuffle your papers again), I’ve seen one permanent loan modification.

It’s depressing to repeat to clients that they have little or no negotiatino power with the lenders.  It continues to be depressing to the economy as the amount of bank owned real estate increases.

As the recession has played out, foreclosure is no longer just the  consequence of sub prime loans and over heated real estate market.  It’s reaching a much broader swath of families.  Falling home values make it economically rational to walk away from underwater properties.

We would all benefit from a legislative “stick” to balance the HAMP plan’s “carrot” for mortgage modification.

As the momentum continues in the judiciary committee to revisit legislation to allow bankruptcy judges to modify mortgages in the context of a Chapter 13 bankruptcy, the mortgage industry is writing letters to the editor of the New York Times to slow down or stop the bill.

David G. Kittle, Chairman of the Mortgage Bankers Association wrote that the modification process has helped 4.5 million homeowners!  How they have helped these people stay in their homes is unknown since the experiences of the non-mortgagers are quite the opposite: that some people have been helped, but, only a fraction of those receiving foreclosure notices.

None the less, Mr. Kittle warns that allowing a bankruptcy judge to modify a home loan will increase bankruptcy filings, and be bad in the long term for the economy and the mortgage industry.  Of course, what he doesn’t say is how bad not allowing such modifications is in the short term with the rising foreclosure rate and families losing their homes now.

The voluntary modification programs have helped some homeowners.  Just not nearly enough. We still need someone to mediate and put some teeth into the process.  Bankruptcy judges are the logical alternative.

Although this was just a preliminary discussion in the Judiciary Committee meeting, it bodes well that this legislation will be brought again.

The Obama modification plans and similar California laws haven’t yielded the relief intended. They remain voluntary so if the lender doesn’t offer a viable arrangement to the homeowner, nothing happens.  A law allowing a judge to oversee the process and put some teeth into it will go a long way to force both the lenders and homeowners to seek a middle ground fair to everyone.  Only in that way, can we stem the foreclosure tide.

As before, the Republicans and some “blue dog” Democrats are likely to oppose the legislation, but as foreclosures continue to rise, homes become more and more “up-side down,” and the current economic down-turn continues, there is hope for this new act.

Recently, the government relaxed the standards for receiving a mortgage modification to include homeowners whose loans exceeded the value of their homes by up to 25%.  As home values continue to decline, more people can now qualify.  But is the system doing anyone any real good?

First of all, it’s not easy to get a modification because of the stringent requirements placed on the process by the lenders.  But even after you navigate through the process the modification you might receive may not do you any real good.  Take a look at the excellent article on the Mortgage Law Network by my friend, David Leibowitz.

And what we are seeing now is that even homeowners who received a modification are defaulting months later.  The Motley Fool says the currently-available home mortgage loan modification programs are ineffective, citing “pathetic” statistics from federal loan regulators that half of the modified loans were in default again three months later. Typical modifications now consist of lowering interest or tacking missed payments onto the back end of the loan.  A scant 1.8% of modifications involved principal reductions.  Thus, as home values decline there is much less incentive to make house payments when you aren’t building equity in the property.

Without judicial oversight, the current modification programs just seem to be delaying the inevitable.

Frankly, attorneys aren’t used to working that way.  They’re used to being paid for the work they do as it is done; not afterwards.  Most attorneys, facing several hours of work, request a retainer from the client in order to insure that the costs and fees incurred get paid.

A standard modification can take three to six months to complete.  During that time the attorney is working hard on the matter, has to pay his staff, his office rent, his expenses, and his mortgage!  Forcing him to wait until the process is over is asking him to lend money to the client.

Not only is this bad business for the attorney, it immediately creates a conflict with the client.  Now, the attorney is forced to get a modification (else he won’t be paid), rather than give the client his best advice which might be to walk away from the house or file bankruptcy if the lender won’t offer a workable solution.

All in all, if this becomes law, I think you’ll see an immediate drop in the number to attorneys willing to attempt a mortgage modification.

That is how a lot of American’s must have felt when the most recent expansion to the Making Home Affordable Plan was announced on July 1st.  For an explanation of the Home Affordable Refinance Program otherwise known as HARP see my previous post.

Now borrowers, who have loans backed by Fannie Mae and Freddie Mac, can refinance up to 125%  of their home’s value.  Sure this will allow more American’s to qualify for a refinance under the plan, but if you are one of those who now qualify you’ve got to be asking yourself, “Do I really want to do this?”

Well do you? Do you really want to refinance your house when the loan to value ratio is over 105%?  That is what the government would like you to do, and now those who are between 106% and 125% loan to value can do it too!

Forgive me if I feel like a kid again.  Like a kid who just saw fireworks for the first time and can’t figure out if it is great or just, as my grandfather used to tell me, “Like burning money”.

Don’t get me wrong, I like fireworks and fanfare just as much as every other red blooded American.  But who among us enjoys being told something will help when in reality doing that very thing is not in our best interest?  I don’t know about you, but I like it even less when I find out later that those who it is really helping are those among us need help the very least.

So, light your fireworks this 4th of July and burn a little money to celebrat our independence.  But before you exercise your freedom to light the big fat stick of dynamite the government just put in your hands, think about the first time you held a firecrecker too long and how your fingers felt.  Oh and don’t forget to multiply that feeling by 125.

Unfortunately, the law is limited in its application to a principal residence occupied by the borrower at the time of the default and only if the loan is the first lien against the residence and was recorded between January 1, 2003 and January 1, 2008.

A mortgage loan servicer can apply to the California Real Estate Commissioner for an exemption to this law (reducing the time period for cure back to 90 days) if they have implemented a loan modification program with specified features. Once the Real Estate Commissioner concludes that the program meets the necessary requirements, the mortgage loan servicer will receive a permanent exemption.

What this means for homeowners is that, under the above circumstances, and if the holder of their first deed of trust hasn’t received an exemption, the homeowner has 6 months from the notice of default to modify the loan, refinance, sell the home or otherwise cure the default.

Enhancements to the Making Home Affordable (”MHA”) plan announced in late April were made, at least in part, because of complications second mortgages presented banks when attempting to modify or refinance a first mortgage. The new provisions, along with the integration of the Hope for Homeowners program, will assist even underwater borrowers by requiring write downs in order to increase homeowner equity, or at least subdue the urge to simply walk away.

Details of the Making Home Affordable Program Update spell out what can be done for amortizing loans as well as interest-only loans.

Amortizing Loans: (Loans on which borrowers make principal as well as interest payments)  Participating servicers are required to take specific steps when modifying amortizing liens in the second position.

1) Interest rate reduction down to 1 %,

2) Extension of the term to that of the modified first mortgage,

3) Principal forbearance on the first lien, with the option of extinguishing principal under what the MHA plan calls the Extingueshment Schedule.

Of course there is a catch, there is always a catch,

4) After five years, the interest rate on the lien in the second position will adjust to the current interest rate on the first mortgage,

5) The lien in the second position will then re-amortize over the remaining term at the higher interest rate, and

6) Investors receive an incentive payment from the U.S. Treasury equal to one half of the difference between the 1% interest rate floor and the modified interest rate on the first lien.

Interest-Only Loans: (Loans on which borrowers make only interest payments) In the case of an interest only loan, servicers are to

1) Reduce the interest rate down to 2%,

2) Forbear principal in the same proportion as forbearance on the first lien,

3) Extinguish principal under the Extinguishment Schedule, if any,

4) After five years the interest rate steps up to the interest rate on the modified first mortgage,

5) The lien in the second position amortizes either over the remaining term of the modified first loan or the originally scheduled amortization term, which ever is longer, and amortization begins at the time specified in the original contract,

6) Investors receive an incentive payment from the U.S. Treasury equal to one half of the difference between the 2% interest rate floor and the modified interest rate on the first lien.

There are also a pay-for-success structure for the second lien program similar to the first lien modification program.  Servicers can be paid $500 up-front for a successful modification and borrowers can receive up to $250 per year for as many as 5 years.  Payments made to the borrower are applied to the principal due on the first mortgage.

To give an incentive to lenders for extinguishing a second mortgage the MHA second lien program provides for an Extinguishment Price Schedule. The Extinguishment Schedule ranges from $.04 to $.12 for every dollar of debt extinguished for loans that are less than 180 days past due at the time of modification.  For loans more than 180 days past due at the time of modification there is no schedule and the lender/investor is paid $.03 for every dollar of debt extinguished.

Thus far the Obama Administration’s solution has been one of financial bargaining with banks, servicers and investors.  The money that borrowers receive in these plans amount to a reduction in loan principle, which is only another payment to the bank.

Time will tell if these changes are effective or whether the borrowers eventually end up in bankruptcy or foreclosure.  Not to mention having the banks and GSEs converting to property managers! For anyone who owns an investment property and can attest to what a headache it is, maybe there will be some sort of justice after all?

This vision was appended by an amendment to a financial act with a number of provisions unrelated to bankruptcy or foreclosure.  Nonetheless, the best chance to see this legislation become law this year has probably just passed.

Bankruptcy judges will continue to have authority to modify almost any other kind of loan except those secured by a personal residence.  That still leaves Chapter 13 bankruptcy as one way to offer some relief to a family struggling to keep their home.  It may not be enough, and the Act would have made a huge difference and saved many homes.  Maybe next year…