Bankruptcy Judges and Loan Modifications

by admin on February 19, 2009

The potential exists that bankruptcy judges may soon be able to modify loan principal balances in favor of the borrower. This process is also referred to as a “cram down” as people who file for bankruptcy protection may be allowed by a bankruptcy judge to lower the balance of the principal loan. If this comes to pass as part of Obama’s Foreclosure Prevention Program, there could be some definite winners and losers. The winners could be homeowners who could possibly get their loan balances reduced to 31% of their overall income. The losers could be banks and the myriad of other debt holders who own a piece of the bundled, packaged and then sold loans.

Homeowners who have previously been stonewalled by their lender and not allowed to modify their existing loan, may now have recourse to bring their lender to the table through the threat of a bankrutpcy judge modifying a loan. There is a definite carrot and a stick approach to the new plan as on one hand you have incentives provided to the mortgage companies and on the other hand you have a strong punishment to the lenders who refuse to negotiate with their borrowers.

The banks see allowing bankruptcy judges to adjust mortgages as a definite loss for them. There a number of reasons for this – to start with the banks and other lenders don’t like being forced to have to write down an asset at the whim on an outside party. Secondly, it could quickly become an administrative nightmare for banks to track down the different owners of many home loans.

The Mortgage Bankers Association is staunchly opposed to allowing bankruptcy judges to execute “cram downs” and allow the primary loan to be adjusted.

It is too early to determine exactly how this is going to play out, but everything points to bankruptcy judges getting more latitude in the ability to adjust primary mortgages for people seeking bankruptcy protection.

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