Judges would be allowed to rewrite mortgage terms under a Democratic plan. Critics fear rate hikes.

By Jonathan Peterson, Los Angeles Times Staff Writer February 26, 2008
WASHINGTON -- Over the opposition of the nation's lenders, Senate Democrats are seeking a change in the bankruptcy law that they say could keep hundreds of thousands of hard-pressed borrowers in their homes.The proposal, part of the Foreclosure Prevention Act embraced by leading Democratic lawmakers, would allow judges to ease the terms of mortgage loans during bankruptcy proceedings.

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Foreclosed: Listings From Pasadena to the Hollywood HillsLenders contend that the measure -- which could be debated on the Senate floor as early as today -- could force them to raise mortgage rates to cover the costs of loans that would not be fully repaid.

They are backed by Republicans, who have proposed more modest changes."If this proposal becomes law, it will amount to a new tax on homeowners, costing them hundreds of dollars more per month and thousands of dollars more per year," David Kittle, chairman-elect of the Mortgage Bankers Assn., said in a statement. "The last thing potential homeowners, and those looking to refinance into new loans, need in this market is higher mortgage payments."Supporters counter that the measure is needed, partly because lenders haven't done a good enough job modifying loan terms so that borrowers can stay in their homes.Chapter 13 of the federal bankruptcy code allows bankruptcy court judges to reorganize an individual's debt, but it does not give them authority to fundamentally alter a person's primary home mortgage.

Although congressional proposals to change the code vary, they generally would give judges new, limited authority to reduce the size of a mortgage and freeze or even reduce interest rates.For example, the Senate proposal, first sponsored by Sen. Richard J. Durbin (D-Ill.) and embraced by Majority Leader Harry Reid (D-Nev.), would empower judges to reduce the mortgage debt to a home's current, fair-market value. The proposal also would grant judges some authority to reduce interest rates that have become unaffordable, potentially saving borrowers hundreds of dollars a month.According to the private industry group Hope Now, 545,000 borrowers got some sort of help from lenders in the second half of 2007.

But foreclosures continue to sweep the nation -- including 31,676 in California in the last three months of 2007, more than double the record set in 1996."[Lenders] put up big statistics about loan modifications, but they're just tacking on some payments at the end, or allowing people not to pay for a certain amount of time," said Hernan Vera, senior attorney at Public Counsel in Los Angeles."They're delaying the problem.

They're not remedying it, long term," Vera said.Advocates maintain that such a remedy can be found by changing the bankruptcy law.Durbin said recently, "We should be giving families every reasonable tool to ensure that they can keep a roof over their heads.""Small changes to an outdated bankruptcy code could help over 600,000 at-risk families keep their homes," he said in a statement, citing a finding of the pro-consumer Center for Responsible Lending.

"That should be our goal."Lenders counter that the ban on altering mortgages serves a valuable purpose, by bolstering lender confidence and keeping capital flowing into the mortgage market.They say the proposed change could backfire by introducing new uncertainties that a borrower would honor the contract, leading to higher rates -- especially for sub-prime borrowers with shaky credit. "It would introduce a major new element of risk into mortgage contracts, and that risk would be elevated for sub-prime borrowers," said Bert Ely, a banking consultant in Alexandria, Va., citing the opposition by lenders.According to the Mortgage Bankers Assn., the measure would force lenders to raise rates by at least 1 1/2 percentage points. In California, that would increase the monthly payment for the average home loan to $2,321, from $1,990, the group said.

Also opposing the measure are the American Bankers Assn. and Financial Services Roundtable. Republicans have generally sided with lenders against the measure, but there are exceptions.

Jack Kemp, the former congressman and secretary of Housing and Urban Development under President George H.W. Bush, recently testified before a House panel that the measure would be an effective antidote to the record surge of foreclosures in the U.S.

"This bill will have more impact . . . than any other option currently on the table," he said.A separate bill sponsored by Sen. Arlen Specter (R-Pa.) would give judges the power to freeze or reduce interest rates on adjustable-rate mortgages. But, in a key difference with the Democratic approach, under Specter's plan the new powers granted to bankruptcy judges would expire in seven years, and lenders would have the right to veto proposals by judges to reduce the amount of principal owed.Supporters of the Democratic bill say they hope to have a floor debate and vote this week. Specter believes the Democratic proposal "should be considered in committee first" rather than offered up for a swift vote on the floor, a congressional aide said. At the same time, an aide to Reid said that the majority leader was committed to the Democratic approach.

"He believes that all the provisions are very important and hopes that the Republicans will allow us to pass the bill by the end of the week," Reid spokesman Jim Manley said.The legislation would also add money for counseling efforts to help struggling homeowners, mandate better disclosures by lenders and provide $4 billion to help communities buy and fix up vacant properties that have become blights on their neighborhoods.But it's the proposed change to the bankruptcy law that has sparked controversy. "There's going to be a hell of a fight over this thing," said Ely, the banking consultant.jonathan.peterson@latimes.com