CoffeeTalk: Should bankruptcy judges be allowed to modify first mortgages (residential deeds of trust)? Why or why not?
Yes, Congress should at least experiment with letting bankruptcy courts treat home mortgages like other secured debts, which can be reworked in chapter 11 or 13 if the creditor is assured the economic value of its lien position. The Bankruptcy Code currently bars modification of home mortgages to make them safer for lenders and therefore more accessible to borrowers.
The housing bubble/meltdown was partly caused by TOO MUCH access. The foreclosure mess has been unnecessarily protracted because banks and loan servicers resist restructuring–especially, principal reductions on underwater loans–for several extraneous reasons, and debtors have no remedy.
Empowering bankruptcy judges to limit senior secured claims to the market value of the corresponding lien right would foster more constructive resolutions in and out of court–banks would net as much or more as they do on foreclosure and resale, and debtors who could support smaller loans wouldn’t be uprooted for nothing. This fix would help the entire housing industry recover. Liberalized modification could sunset in, say, five years, and Congress could allow the amendments to lapse if home loans had become too scarce as a result.
- David I. Katzen, Katzen & Schuricht
It is a logical approach to a difficult, wide-spread problem. One of the reason that so few loan modifications are being completed is that the lending industry has no real obligation to be responsive to the needs of its borrowers. The argument against modification in bankruptcy is that it will end residential lending as we know it. The same argument was made against loan modification under Chapter 12 (farm lending would dry up or be too expensive); it didn’t happen. The bankruptcy system works because there is a more level playing field for debtors. My personal belief is that if loans (for the debtor’s primary residence) could be modified in bankruptcy, more loan modifications would be done outside of bankruptcy because, for the first time in ages, borrowers would have leverage.
- Alan Ramos, Steele, George, Schofield & Ramos, LLP
The power of Courts to modify contracts, including first mortgages, should be limited and dependent upon the facts of each case. Is the Trust Deed a Purchase Money Mortgage? Is the secured property “under water”, worth less than the amount owed? Have the parties tried to work out their own solution (e.g., by negotiation or mediation). Is the lender a commercial business, e.g. a bank/institutional lender, who could extend a loan for a longer term without any loss, or a private party, e.g. an elderly widow with limited resources who would be harmed by the modification? A good mediator could help guide the parties to a win win solution. A Court may just have to “cut the baby in half”.
- Joel Zebrack, Attorney / Mediator
Although these probably aren’t the situations that concern most people, bankruptcy judges actually can modify first mortgages when (a) the real estate involved isn’t the debtor’s principal residence or isn’t the only security for the loan or (b) in Chapter 13, the entire mortgage debt will be due within five years after the date the case is filed. With respect to a loan that isn’t due within the next five years and is secured only by a senior deed of trust on a person’s principal residence, the arguments in favor of allowing the terms to be modified in Chapter 11 or Chapter 13 are probably obvious; the counterargument is that allowing such loans to be modified will cause mortgage loans to become more difficult to get and to have more onerous terms.
- David A. Schuricht, Katzen & Schuricht
Filed Under: Question Man