Common Sense: Use the Courts to Curb Foreclosures

First of all, I want to thank Shannon for inviting me to post about judicial loan modifications on this great blog. It's good to be here!

As we all know, our nation is in the midst of a foreclosure crisis. 8.1 million homes are now expected to be lost, which equates to almost 1 in 6 homes with a mortgage. A few years ago Americans for Fairness in Lending (AFFIL) made an ad campaign depicting one the effects of foreclosure: you guessed it -- homelessness. [Check out our "Family in the Woods" ad here.]

Foreclosure is a tragedy in itself, and it also has had a profound ripple effect upon neighborhoods and our entire economy. The Woodstock Institute estimates that "families lose approximately 1.14 percent of their house value for every foreclosure that occurs on their block." And to read about the link between rising foreclosures and our current recession, visit the Center for Responsible Lending.

The programs the government has designed to prevent foreclosures haven't worked. Hope for Homeowners, for example, was supposed to keep 400,000 families in their homes - but has only refinanced twenty-five loans to date.

Yes, that's twenty-five total, not twenty-five hundred or twenty-five thousand.

One big problem with Hope for Homeowners and other programs is that they're voluntary. Loan servicers (the companies that collect mortgage payments and disperse them to the investors who really own the mortgages) can participate, but they don't have to. Their contracts usually pay them more for foreclosing on a homeowner than for working our a loan modification. And servicers are edgy about arranging modifications because they can be sued by the investors, some of whom stand to lose from modifications, although some may stand to gain.

Which brings me to a solution that could work, if Congress would give it a try: judicial loan modifications. What this proposal would do is give bankruptcy judges the authority to adjust the principal amount on mortgages on owner-occupied homes so that they match the current value of the homes. The adjustment to the principal is sometimes colorfully referred to as a "cram down." The judges could also lower the interest rate or increase the period for repayment so that the monthly payments will be affordable for the homeowner.

In addition to saving homes for people actually forced to file bankruptcy, this practice could serve as a stick for servicers fearing that borrowers will might declare bankruptcy to save their homes. The servicers could be motivated to modify the loans themselves before the borrower actually chooses this option.

The New York Times estimates that this program could save 500,000 homes. Clearly, more will be needed to combat the upcoming 8.1 million foreclosures, but this is a good start (and a heck of a lot better than Hope for Homeowner's 25 modifications!). And importantly, this fix wouldn't cost taxpayers a penny.

Nonprofit advocates and experts can't say enough good things about allowing judicial loan modifications. The New York Times alone has run at least three editorials about it in the past few months, including this one on the day of President Obama's inauguration (see two more here and here).

Stay tuned for more info about how, and when, Congress might make this common sense change to the law.