Bankruptcy 'tweak' could save 600,000 homes

Consumer group pushes for change to bankruptcy law; others worry about negative impact on mortgage-debt markets.

One consumer group estimates that 600,000 foreclosures could be avoided over the next two years by making a simple change to the bankruptcy code.

The Center for Responsible Lending (CRL) calls it a tweak, but it could be a significant change for homeowners and the market for mortgage-backed securities.

CRL's proposal - reflected in a House bill recently introduced - would make changes to the regulations for Chapter 13 bankruptcies, which don't wipe out debts, but rather establish a repayment plan.

Under current law, when a person files for Ch. 13 bankruptcy, judges cannot reduce mortgage debt owed on a person's primary residence, although they may modify mortgages on investment property or second homes.

Under the House bill, the bankruptcy judge would have the option of reducing what the homeowner owes the lender. Say a homeowner's property is worth less than what he owes. The judge could reduce the principal to match the home's current market value as well as reduce the loan's interest rate.

The rest of the original principal would then be treated as unsecured. That means it becomes a lower priority for repayment than the borrower's secured debt, such as the newly reduced principal on his home. Unsecured debts may be discharged.

This is exactly what should be done. The homeowner gets some reprieve on what is owed and can negotiate a better loan and the bank avoids a costly foreclosure. Look for the pro business crowd to scream loudly that this will ruin the market but what other options are available? They should have been screaming when these lending institutions were making loans to people without proper documentation. Its amazing how quiet the business community is when they are making huge profits off the backs of those that can least afford it. It is time for them to feel the same pain as those they tricked into these awful loans.