New Bill Would Repeal Home Mortgage Exception During Bankruptcy

A new bill introduced today by Reps. Brad Miller (D-NC) and Linda Sánchez (D-CA) seeks to repeal the home mortgage exception in the current U.S. Bankruptcy code:

… the Miller-Sánchez bill will treat home mortgages the same as mortgages on investment properties and family farms. The bill repeals a provision that prohibits a bankruptcy court from modifying a home mortgage, but allows a bankruptcy court to modify any other secured debt, including mortgages on other properties.

Called the Emergency Home Ownership and Mortgage Equity Protection Act (H.R. 3608), the bill would make it possible for a bankruptcy court to restructure a home mortgage — meaning a bankruptcy judge could change interest rates or alter principal amounts as part of a Chapter 13 restructuring plan.

If you work in the mortgage industry, this bill should give you strong pause. From an investor’s perspective, most structured securities are generally designed to account for prepayment and default risks — and not an additional restructuring risk due to borrower bankruptcy. (And I think we all know how well many of these securities have accounted for the expected impact of the first two risk factors.)

But it doesn’t really stop there. If I’m understanding the bill correctly, I believe it would eliminate the “relief from stay” from a lender’s/servicer’s legal toolkit during property repossession and disposition. The result would seem to inevitably be an increase in the timelines surrounding default management and REO disposition, introducing a new cost source that would place further pressure on an investor or insurer’s ability to recoup some of their losses.

Making it more difficult for lenders to take back homes when a default takes place — whether or not a forced modification is approved during bankruptcy — also hurts consumers, not just those making the loans. Consumers will either be charged higher rates to compensate for the higher risk of loss given default, and many lenders themselves will become less likely to lend to consumers whose credit profiles mark them as a relatively greater default risk. (That would be subprime.)

In case you missed it: if enacted, this bill will likely have the unintended effect of hurting the very group it is purported to help. Given the lack of options already facing many subprime borrowers today, I just don’t know how much I can get behind a bill that seems likely to further thin out the herd of available options even further.