For the first time, individuals filing for bankruptcy protection may soon be able to reduce principal and interest on home mortgage obligations and prevent enforcement of certain mortgages even after entry of a foreclosure judgment.

Under existing law, individuals can propose changes to the amount owed and interest rate on secured loans in Chapter 13 repayment plans, but rights of home mortgage holders cannot be modified. The Helping Families Save their Homes Act of 2009, passed yesterday by the House, would vastly alter bankruptcy treatment of home mortgage claims. The changes would, among other things:

  • Exclude home mortgage debt from the computation of maximum secured debt eligible for treatment under Chapter 13 repayment plans.
  • Prohibit claims under home mortgages subject to rescission under the Truth in Lending Act, even after entry of a foreclosure judgment.
  • Under certain conditions, permit individuals to modify the terms of mortgage loans in foreclosure, including extending the repayment period to up to 40 years, reducing principal debt to the value of the property, and reducing the interest rate.

To be eligible for mortgage modification, the consumer would have to certify that he/she attempted to contact the mortgage holder at least 15 days before filing to seek modification of the loan, or that a foreclosure sale was scheduled within 30 days.

In addition, last minute amendments to the bill would require the bankruptcy court to determine whether the modification request is in good faith based on whether the debtor was offered a mortgage modification in accordance with the Administration's Homeowner Affordability and Stability Plan ("HASP"), and was able to afford those payments. The Court could also consider lowering the interest rate to reduce the debtor's mortgage payments to bring the borrower's debt to income ratio to 31% as provided under HASP, instead of reducing the principal on the loan.

A recent Mortgage Bankers Association survey reported nearly 12 percent of homeowners were in foreclosure or behind on their payments at the end of 2008. The new law would effectively force modification of some mortgages on servicers and holders who refuse to do so voluntarily.