Written By: Alan S. Wolf
You’re special. Did you know that? From the inception of the Bankruptcy Reform Act in 1978, and in all the revisions that have followed since, mortgage lenders have had an honored and exulted place in the Bankruptcy Code. This is a result of Congress’s recognition that home mortgages in general, and the secondary market in particular, are highly important to our economy. Thus, while a debtor in bankruptcy can strip down virtually all secured debt, a debtor cannot strip down a mortgage loan if the property is the principal residence of the debtor when the bankruptcy case was filed. Similarly, while a debtor can redeem property by paying the fair market value of the property despite the secured debt being greater, a debtor cannot redeem his real estate without paying off all the secured debt. And in a Chapter 13 case, the debtor can only cure by paying the amounts due under the mortgage documents and non-bankruptcy law. Those are just some of the very special protections in bankruptcy afforded to mortgage lenders but not provided to other secured creditors (unsecured creditors are treated even worse). These are valuable rights, and they are about to be lost.
On April 12, 2007, the National Association of Consumer Bankruptcy Attorneys, the Consumer Federation of America, and the Center for Responsible Lending made a big push in Congress to eliminate these rights. They have wanted these rights eliminated for some time, but making the push at this time was brilliant — they tied the need to these changes as a solution to the subprime debacle. Congress has been looking for a simple solution to the subprime/foreclosure problem. The consumer groups have made the pitch that changing the Bankruptcy Code to eliminate the special protections afforded to mortgage lenders is that simple solution.
Specifically, here is what the consumer groups want and their rationale for wanting it:
▪ Amend Chapter 7 of the Bankruptcy Code. “One problem facing debtors who are trapped in high-cost loans is the inability to refinance out of those loans. So, for example, a debtor who owes 125 percent loan-to-value (LTV) on a home must come up with a lender who will finance a 125-percent LTV mortgage — leaving the debtor in much the same difficulty. The inability to strip down a high LTV mortgage gives the first lender a stranglehold over the debtor, as payments and fees rise and the debtor’s only option is to give up the home.” Holders of personal property can “redeem” their property by paying the creditor the current value of the property; owners or homes should get the same right.
▪ End the Bankruptcy Code’s special treatment of home mortgages. “In order to address problems resulting from the Code’s disempowerment of bankruptcy judges to modify home mortgage debt, Congress should eliminate the exception, putting home mortgage loans in parity with other secured debt.” This step also will put middle class homeowners in parity with wealthy debtors, who currently are able to save second and third homes in bankruptcy because they fall outside the currently restrictive mortgage provisions that apply only to primary residences.
▪ Remove time-consuming credit counseling requirements. “As a result of the 2005 amendments [to the Bankruptcy Code], an individual cannot even meet the definition of a ‘debtor’ (and so cannot file for bankruptcy) without first receiving credit counseling from an approved credit-counseling agency. Requirements like these cost precious time, which a borrower facing foreclosure cannot afford to lose.”
▪ Curb excessive fees during bankruptcy. “Another necessary change is a provision to control the enormous problem of mortgage companies adding unauthorized or excessive fees to the accounts of debtors who are in chapter 13. Many of these debtors emerge from a chapter 13 case after three to five years of struggling to cure an arrearage only to have the lender assert that they are several months behind on their payments due to fees for such items as attorneys’ fees, broker price opinions, and other charges allegedly incurred during the chapter 13 case, and which they were never informed of before. Many bankruptcy courts have decried these abuses, but usually they go unremedied because the bankruptcy case is over and the debtor has no money to litigate about them. Sometimes, the fees are not even revealed to the debtor until the debtor pays off the mortgage balance upon selling the home or refinancing. A provision to remedy the problem of excessive fees could provide that all fees and charges based upon occurrences during the pendency of a chapter 13 case must be approved by the court … ”
▪ End mandatory arbitration in bankruptcy. “The enforcement of these arbitration agreements under the Federal Arbitration Act is often in direct conflict with the goal of bankruptcy jurisdiction to have one centralized forum for the prompt resolution of disputes affecting the bankruptcy estate.”
▪ Create a minimum homestead exemption for the elderly. “These debtors cannot save their homes by refinancing because they cannot afford the monthly payments that would be required and cannot file Chapter 13 cases to save their homes because current law would require paying the value of their nonexempt equity to unsecured creditors.”
Those are the highlights. As an industry, mortgage servicers took a back seat to the latest changes in the Bankruptcy Code (BAPCPA, generally effective October 17, 2005). I suspect this had to do with the fact that most mortgage servicers are owned by banks, and the banks wanted to protect their credit card and auto divisions. What protects unsecured debt and cars makes less money available to pay mortgages — but the choice was made and the results on the whole were somewhat neutral to mortgage servicers (there were some good things, there were some bad things — in the end it was a wash).
The new proposed changes strike at the heart of our special place in the Bankruptcy Code. It would be disastrous to take a back seat in this fight. It is my hope that the entire industry can galvanize its efforts to thwart these proposed changes. It’s nice to be honored and exulted. Let’s try to keep it that way.