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MORTGAGE "CRAM DOWNS" - Forced Principal Reduction on Primary Home Mortgages in Event of Borrower BK - Suggested Under New Obama Plan!

In an attempt to forestall the rising number of foreclosures across the country - and help some distressed homeowners in danger of losing their homes, the Obama Administration last week proposed his new $75 Billion Housing Recovery Plan. 

One component of the plan involves incentivizing lenders to modify loan terms for a select group of home owners who might be "underwater" in their mortgage - in other words, they owe more on their home is worth in today's market.

(For an outline on the specifics of this plan, read this article in the Wall Street Journal by reporters James Hagerty and Lingling Wei.)

The new program, however, comes with an important modification that, if enacted, might "persuade" reluctant lenders to modify certain troubled loans.  That modification - the ability of U.S. Bankruptcy Court judges to reduce the principal amount owed on the mortgage loan of the defaulting borrower's primary residence. 

Faced with a threat of such a principal reduction might "persuade" reluctant lenders to modify a distressed client's loan to a more attractive interest rate and terms, rather than risking principal loss should the borrower end up filing for bankruptcy.

Currently,  BK judges can wipe out thousands of dollars of secured and unsecured debt on behalf of a debtor filing for bankruptcy.  They can reduce the amount of principal owed on investment property.  But they are now prevented from reducing the balance owed on a mortgage loan for a primary home.

Such a change has long been fought by lenders, as well as the Mortgage Bankers Association.  They fear forcing these principal reductions - called "cram downs" in the industry - could create new losses for banks, as well as instability in mortgage investment markets, and ultimately, higher interest rates as lenders better hedge their bets against these potential losses.

The program's proponents contend the helpful impact to those facing imminent financial collapse would far outweigh the yet-unproven response of higher interest rates. One Congressman who supports the bill, Democrat John Conyers of MI, blames banks for not acting fast enough to stem today's mortgage crisis.

Please see the Hagerty/Wei Wall Street Journal story for more.

Also read our post via BlogChicagoHomes.com.


Comment balloon 5 commentsDean Moss • February 23 2009 12:55AM


This is one of those that elicits passionate responses on both sides of the fence.  No matter how you slice it somebody loses.

Seems to me that the litmus test on a cram down should be how much money a homeowner brought to the table.  If they came in with 0 down, then they shouldn't get any relief.  They didn't risk anything.

However if they came in with money down, then the relief would be warranted.

That said, everyone loses in a foreclosure.  The investors will nearly always lose part of the capital investment due to foreclosure.  A loan modification that assures continued cash flow and future capital recapture simple makes sense.

Posted by Kate Bourland, Onlilne Marketing Mobile Marketing (Marketing with Kate) about 10 years ago

Dean: I read that article as well. It'll be interesting to see that in practice.

Posted by Matt Grohe, Serving the metro since 2003 (RE/MAX Concepts) about 10 years ago

I've been advocating that relief for the American home owners for over a year or more. 

For one thing, the institutionalized stima that attaches to "bankruptcy" will deter all but the most desperate.  Most folks don't realize that the absolute worse thing one can have on a credit report is a foreclosure, yet daily, they submit to foreclosure when bankrutpcy, even today with out cramdown, could help many reorganize their debt. 

BTW, I don't believe that it was the Mortgage Bankers Association that has kept this legislation from proceeding.  It was the MONEY that the Mortgage Bankers Association's lobbies contributed to key Congressmen and Senators that prevented this relief for home owners. 

Any time one wants to know what happens on Capitol Hill, just follow the money. 

Posted by Lenn Harley, Real Estate Broker - Virginia & Maryland (Lenn Harley, Homefinders.com, MD & VA Homes and Real Estate) about 10 years ago

Great topic for a lively discussion.  I for one would not want to have a judge throwing out a valid contract and reworking the terms of the loan.  If persons are wondering why thing are going to get a lot worse before they get better this is one of the main reasons.

That tells me:

  1. No contract is worth the paper it is written on.
  2. Why should I risk my capital if the terms can be reworked by a third party?
  3. Why will lenders lend money if a judge can re-work the mortgage?
Posted by Jim Crawford, Jim Crawford Atlanta Best Listing Agents & REALTOR (Crye-Leike REALTORSĀ®) about 10 years ago

Dean, if a lender lets it get all the way to BK court, they SHOULD be forced to modify the terms.  I know many of these homeowners, and they have DESPERATELY tried to work with the lender to get an affordable payment, but the lender refused to cooperate!  The homeowner who tries to work it out with the lender through BK court has already been through the ringer but refused to walk away and let the bank foreclose, they have more integrity than many who just walked away.  The lenders then lose EVEN MORE when they have to do a foreclosure, but somehow they don't seem smart enough to figure that out!

Great blog, thanks for posting at http://activerain.com/groups/virtualoffice

Posted by Regina P. Brown, M.B.A., Broker, Instructor (MBA Broker Consultants) about 10 years ago

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