Bankruptcy Laws Contributing to Foreclosure EpidemicConsumer Affairs
April 13, 2007
Bankruptcy law changes are needed if hundreds of thousands of American families struggling with abusive subprime mortgages are going to escape foreclosure and the loss of up to $164 billion in home-based wealth, according to a joint call for Congressional action issued by the National Association of Consumer Bankruptcy Attorneys (NACBA), the Consumer Federation of America (CFA) and the Center for Responsible Lending (CRL).
The three consumer groups warned that -- while primarily low-income subprime mortgage borrowers face often insurmountable bankruptcy hurdles to hold onto their homes -- high-income individuals in bankruptcy court get preferential treatment when they seek to save second and third homes.
"The only chance many of these (subprime) borrowers have is through declaring bankruptcy," the groups said. "The problem is that as currently enacted, the Bankruptcy Code favors home mortgage lenders over virtually all other secured and unsecured creditors."
The amendment disfavoring protection of the debtor's principal residence was added at a time -- 1978 -- when home mortgages were nearly all fixed-interest rate instruments with low loan-to-value ratios and were rarely themselves the source of a family's financial distress. As a result, bankruptcy law singled out the home mortgage loan as the major debt for which the bankruptcy court is powerless to provide relief, they said. "Since that time, the mortgage market has shifted considerably. Subprime lending practices of the last six years, which have relied on property appreciation, and in many cases appraisal fraud, have left many borrowers with mortgages larger than the value of their homes. If the borrowers cannot restructure these debts, then they cannot get back on their feet financially."
Philadelphia bankruptcy attorney and NACBA President Henry Sommer said help is urgently needed for hundreds of thousands of American families at risk of losing their homes due to abusive home loans.
"For most of these families, bankruptcy is the only viable option to save their home, and this option will be available only if the Bankruptcy Code is revised to eliminate or limit the provisions that exclude home loans from bankruptcy protection," Sommer said. "This current exclusion is contrary to sound policy, and operates to disadvantage low-wealth and middle-income borrowers as compared to debtors with the wealth to own more than one home."
Allen Fishbein, director of housing and credit policy of the Consumer Federation of America, said two million or more homeowners face foreclosure over the next few years, with many of these resulting from negligent and reckless lending practices by mortgage originators.
"A sizable number of borrowers find themselves in this situation because their mortgages are larger than the current value of their homes. Modifying the bankruptcy laws to permit the write down of certain toxic mortgages would provide a critical life-line for these at-risk families to hang on to their homes. We urge the Congress to act," Fishbein said.
"Today we have an epidemic of homeowners who are in serious financial trouble, and whose houses are worth less than the balance due on their loans because of the irresponsible lending practices of subprime lenders," he said. "To make matters worse, bankruptcy laws will actually prevent these families from recovering. Subprime loans have pushed millions of households under water; unless Congress makes some common-sense changes, our current laws will ensure that they drown."
As 2006 drew to a close, 2.2 million households in the subprime market had either lost their homes to foreclosure or held subprime mortgages that likely will fail over the next several years absent intervention, the groups said.
These foreclosures will cost these families their homes, along with up to $164 billion in lost wealth. For increasing numbers of borrowers, foreclosure is the only option available. Lehman Brothers has estimated that 30 percent of subprime loans originated in 2006 will end in foreclosure.
The joint statement recommends a wide range of specific bankruptcy law changes, including the following:
• End the Bankruptcy Code's special treatment of home mortgage loans.