Bankruptcy Courts Set to Gain More Authority

by admin on February 25, 2009

This Thursday February 26, 2009, the House of Representatives is going to review a bill to give bankruptcy judges much more power regarding 1st mortgages. If the bill passes it is expected that bankruptcy judges would have the authority to make significant reductions in primary mortgages and in addition there would be protection for mortgage servicers from the mortgage owners. Also tucked into this bill is a proposed increase in the FDIC insured deposit limit to $250,000.

Bankruptcy judges would have the ability to treat primary mortgages like many other unsecured debts that can be “crammed down” and significantly reduced during the bankruptcy process. Much of this discussion in the House is coming because of Obama’s announcement last week about the new Foreclosure Prevention Program. This plan to give the bankruptcy judges more latitude is aimed squarely at mortgage lenders so they are now strongly encouraged to give a loan modification to homeowners so they can avoid having their loan go into bankruptcy and severely reduced.

In my opinion there should be a wave of modifications coming as lenders realize they could be left with a foreclosed home or an owner who only has to pay back $.50 on the dollar for their primary mortgage loan. This should strongly motivate lenders to write down or modify part of the loan principal balance with the goal of keeping the homeowner paying their mortgage and slowing the growing tidal wave of foreclosures. Of course with the fate of this bill still very undecided, things may change in either the House or the Senate as they review it’s merits and weaknesses over the coming days.

House Republicans are mostly opposed to giving bankruptcy judges this amount of power in modifying primary mortgages. There should be quite a lengthy discussion during the next few days and it wouldn’t surprise me to see some tight restrictions placed on judges in terms of how they modify principal balances on primary home loans.

We can’t forget that their are still incentives for lenders to make loan modifications. Obama’s plan called for $1,000 a year for up to 3 years if the lender can keep the loan owner current on their payments.

It will be interesting to see how this plays out, but it appears that now there will be some strong incentives to at least get home owners and lenders to the table to have a negotiation about their mortgage balances.

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