Specter's Mortgage Relief Bill Not Much Help: Home Owners? Mortgage and Equity Savings Act

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U.S. Senator Arlen Specter, R-Pa., has offered his version of relief for homeowners who are in bankruptcy because they can no longer afford their mortgage payments.

Specter’s Home Owners’ Mortgage and Equity Savings Act seeks to provide relief to low and moderate income homeowners whose ARMs are being broken by interest rate resets.

The HOMES Act will allow bankruptcy judges to:

• Delay, prohibit or roll back interest rate increases.
• Waive early repayment penalties.
• Recover interest, fees and penalties when creditors are found to have committed fraud or failed to disclose material loan terms.
• Write down principal on a mortgage when lenders and borrowers agree.
• ¨Delay credit counseling until after filing when foreclosure is imminent.

Specter proposes that consumers with “current monthly income” of 150 percent or less than the median family income for their state be allowed to stop or delay mortgage resets, or set back resets that occurred during the prior two years. They could also waive prepayment penalties.

Where Specter falls flat is on “cramdowns,” which is modifying the principal balance of the mortgage down to the home’s current fair market value.

Specter’s proposal would allow cramdowns, but only if the lender agrees. Anyone who’s seen It’s a Wonderful Life will agree that cramdowns will not happen unless lenders’ arms are twisted.

Specter claims that if mortgages are subject to cramdown in Chapter 13 then future borrowers will be forced to pay more for their mortgages to adjust for the risk the lender is taking that borrowers might file bankruptcy and try to cramdown their loans.

Whether cramdown is forced down lenders’ throats or not, mortgage lending is likely to become riskier, driving rates up.

Why?

Because borrowers who can’t reduce principal balances to market will be unable to make their mortgage payments and will walk away from houses. This is happening now, and is likely to continue in 2008. Lenders will then have to foreclose and maintain the property, and likely sell for less than the current market value. To allow a bankruptcy judge to mark down the balance of a mortgage, keeping the homeowner in it and paying, seems to be a better deal for lenders than the alternative of becoming landlords to empty houses.

But it’s the current monthly income clause that makes Specter’s bill unrealistic. Requiring borrowers to be on the lower-end of state median incomes is like trying to catch a rainbow. You can see it, but you can’t touch it.

The CMI is a calculation of past income based on any money that came into a borrower’s hands in the previous six-month period. This calculation can change from month to month, so someone who is unlucky enough to have to file when their CMI is 151 percent of median income receives no benefit from Specter’s bill. Imagine how they would feel if their income dropped to 149 percent the next month.

Another wild card in his proposal: As a state’s median income goes down because fewer people have good jobs, more families may find themselves unable to take advantage of Specter’s proposal because they were “unlucky” enough to have a good income.