During his speech Monday in Elkhart, Ind., President Obama suggested that one way to help the millions of Americans with upside-down mortgages — mortgages in which they owe their lender more than their house is worth — would be to change the bankruptcy laws and give judges the authority to modify the terms of a mortgage for someone’s only home. Right now, the law allows judges to modify mortgages for additional homes, but not for someone’s sole residence.
“Now, that makes no sense,” Obama told the crowd. “What that’s doing is it’s forcing a lot of people into foreclosure who potentially would be better off, and the bank would be better off, and the community would be better off if they’re at least making some payments, but they’re not able to make all the payments necessary.”
We were disappointed that such practical legislation wasn’t included in the stimulus compromise agreed to Wednesday. Bankers and others in the mortgage industry worry that such a change would all but dry up the market for second mortgages and could raise rates for all new homeowners. But the industry and the broader economy have much more to lose if these struggling homeowners can’t work out a compromise with their lending institutions.
Iowa City bankruptcy lawyer Steve Klesner said he thinks it’s necessary to grant judges this authority because so many mortgages have been repackaged, rebundled and resold to so many different lenders that it’s sometimes impossible to figure out which — or even how many — of the lenders need to sign-off on the modifications. And some lenders simply never agree to any modifications.
Empowering judges to be decision-makers would increase the possibilities of finding an agreement in the best interests of the lender, the borrower and the neighboring landowners.
When is it right to walk away?
If Congress doesn’t move forward with granting judges this authority, far too many people over the next few years could have to decide whether it’s in their best interest just to walk away altogether from their mortgage.
Klesner said many homeowners view the option as ethically dubious at best and wouldn’t even consider following through with it. Others who eventually hope to find jobs in management or in public service will need to decide what’s more costly to their long-term goals: paying off the mortgage or enduring the stain on their credit record.
And even the remaining homeowners — those who, after looking at their situation dispassionately, decide that walking away makes sense — need to know what they are in for.
Iowa law gives lenders two options when deciding to foreclose on property:
* If lenders choose to use foreclosure without redemption, they just go after the legal title to the property and don’t go after the borrower to make up any shortfall between how much is owed and how much the property eventually sells for. After being served with a foreclosure without redemption notice, the borrower can ask for six months to vacate the property.
* If lenders choose straight foreclosure, then they reserve the right to go after a borrower to make up any shortfall. But the process takes longer because the borrower can ask for one year to vacate the house.
Because most lenders don’t want to have their properties sitting around depreciating for an entire year, foreclosure without redemption is the dominant form in Iowa. Before the current housing crisis, it was almost assumed that, if a foreclosed home only had one mortgage on it, the lender wouldn’t go after any shortfall.
Klesner said in the past year, however, there’s been a noticeable increase in the number of lenders using straight foreclosure even when a home doesn’t have second mortgage — probably because lenders facing increased numbers of mortgage defaults need to make up the money somehow. It’s not a huge increase, but it’s no longer an absolutely safe bet that lenders won’t go after people who decide to walk away from a first mortgage.
Help homeowners avoid the dilemma
But the bet still is safe enough for some.
If Iowa City flood victims are facing a mortgage costing more than the post-flood appraisal of their homes, and if they’re also facing more than $50,000 in repairs on top of that, they might want to consider walking away if their property only has one mortgage on it.
If their lenders choose foreclosure without redemption, they can absorb the devastating financial loss and try to move forward with their lives — even though they’ve probably lowered the home values of their neighbors’ properties. If their lenders choose straight foreclosure, they’ll need to declare bankruptcy anyway and try to protect their remaining assets.
With the proposed change in bankruptcy law, judges could help many homeowners avoid facing this dilemma in the first place. It wouldn’t keep every home out of foreclosure, but it would give homeowners more options.