Bankruptcy courts would be allowed to alter mortgages written by predatory lenders in moves that could save 600,000 Americans from foreclosure, according to the author of a bill introduced in the U.S. Representatives on Friday.
The legislation would repeal a provision that prohibits a bankruptcy court from modifying a home mortgage, according Representative Brad Miller, a North Carolina Democrat, who sponsored the bill along with Democrat Linda Sanchez of California.
The bill is co-sponsored by Barney Frank, a Massachusetts Democrat and chairman of the House Financial Services Committee.
Delinquencies and foreclosures have soared in the past year in the United States, putting the spotlight on ways to modify loans that are resetting to higher interest rates. One problem is that most mortgages made in recent years are contained in mortgage securities, many of which hold covenants that do not allow a lender to change the terms of a loan.
Bankruptcy law bars mortgage restructuring even when a foreclosure is near. Foreclosures are expected to rise as payments on some 5 million adjustable-rate mortgages increase over the next 18 months.
Responsible lenders who made loans on reasonable terms have nothing to worry about in bankruptcy court, Miller said in the statement. Predatory lenders may be saddled with the loans, he said.
Under loan modifications, the lender and loan-servicing company change the mortgage terms to make them more affordable to the borrower. This can include lower interest rates and forgiving a portion of the principle.
Wall Street and bond rating companies have criticized loan modifications since investors who bought the riskiest portion of the bonds may be treated more favorably than owners of safer slices once a loan is modified.
The bill may encourage lenders to do more modifications, which are now few and far between, Miller said in an interview. A report by Moody's Investors Service last week found that lenders eased borrowing terms on just 1 percent of subprime mortgages with interest rates that reset higher in January, April and July.
Everyone will know what will happen in bankruptcy, so the fact that bankruptcy is an option would lead to negotations ahead of that event, he said.
Despite the hurdles, modifications are seen as still the best alternative for the $7.2 trillion mortgage bond market, which is credited for both raising money for the U.S. real estate boom and the excesses that brought housing to its knees last year, according to the American Securitization Forum, a lobbying group. Foreclosure is more costly for lenders and investors, it argued.
The bill is also co-sponsored by Democrats Carolyn Maloney from New York and Mel Watt from North Carolina.