New Bill For Foreclosure Avoidance Could Cause 500,000 New Bankruptcies

Posted on November 8th, 2007 by saman

A new foreclosure prevention bill proposed by House Democrats intended to help 600,000 homeowners avoid foreclosure might actually result in the same amount of personal bankruptcy filings between now and 2009 according to some critics. The bill, introduced by Representatives from California and North Carolina, features a provision that would permit bankruptcy judges to modify mortgage terms on a homeowner’s primary place of residence by reducing the interest rate and other mortgage loan features. The Director of the American Bankruptcy Institute in Alexandria, Virginia has told Congress that the new bill could result in as many as 500,000 new bankruptcy filings and that they should carefully consider the implications. Representative Brad Miller of North Carolina responded by saying that the proposal underlying the new bill was made by bankruptcy judges who had certainly considered the implications.

According to statistics from a database managed by eSources LLC, there were 575,735 new bankruptcy filings in the period between January, and September 2007, representing a 44% increase over the same period in 2006.

This Congress, which is under Democratic control, is very eager to turn around those provisions of existing bankruptcy laws that they deem to be unfair to workers and consumers alike. The recent rash of sub prime mortgage foreclosures and lower housing prices has resulted in the idea of changing bankruptcy laws to gain new momentum. The Chief Economist of Moody’s recently told a House Judiciary Committee that he expects 2,000,000 new home foreclosures during the next several years and that 500,000 of these can be prevented.

Right now, lenders can change the terms of their mortgages to help homeowners avoid bankruptcy by lowering payments. However, very few mortgages in a default situation have actually been modified, as many lenders are reticent to make the necessary changes. Current law does not permit bankruptcy judges to force lenders to make changes in the terms of a loan. The new law being proposed would allow bankruptcy judges to order lenders to make the required modifications so that homeowners would have manageable monthly payments. This idea, however, is not popular with most lenders who would have to make it much more difficult for many borrowers to obtain a new loan.

The new bill would primarily affect homeowners who file Chapter 13 bankruptcy (reorganization) because they plan to repay their debt over the specified time period. Therefore, backers believe that the bill would not increase the cost of mortgage credit, lead to significant abuse or disrupt secondary markets.

Critics like the American Bankruptcy Institute also believe that the bill would result in a major increase of bankruptcy filings because they would represent ‘a way out’ of imminent mortgage foreclosure. ABI currently represents more than 11,000 bankruptcy lawyers, restructuring professionals and accountants. ABI believes the change in bankruptcy laws would lead to a sharp increase in bankruptcy filings from people facing foreclosure and also that it would increase business for Chapter 13 attorneys and home appraisers.

Right now, despite opposition from bankers, the bill is passing through Congress. The House Judiciary Subcommittee approved it last month by a 5-4 vote and it could be voted on in the very-near future.