How Will Mortgage Modification Work under the New Bankruptcy Law?

01 Feb How Will Mortgage Modification Work under the New Bankruptcy Law?

How does the (proposed) bankruptcy law, known as Helping Families Save Their Homes in Bankruptcy Act of 2009, actually work?

Here is an example:

Joe is a successful Jacksonville plumber who is a sub-contractor for ACME Homebuilders.  In June of 2005, he and his wife purchased a house for $440,000 with 80/20 financing.  They have a first mortgage in the amount of $352,000 and a second mortgage in the amount of $88,000.

The first mortgage has a variable interest rate that was fixed for the first three years of the loan (a 3/27 ARM).  The initial teaser rate was 5%, but nine months ago, the ARM reset to 8.25%.  The second mortgage has a fixed interest rate at 8.00%.

Nine months ago, when the teaser rate reset to the current rate, and the first mortgage payment shot up to $2,645.  Even though the second mortgage payment remained at $708, the overall payment was too much.  Joe could no longer afford the payment and is 9 months behind in the both mortgage payments.  The first mortgage has filed a foreclosure, and it would take $27,000 to reinstate the loan.  The second is $8,500 behind.

Joe has unsuccessfully attempted to discuss modification with the lender, as he has been hurt by the collapsing economy.  His $100,000 plumbing income has been cut in half, and the market value of the home is now $310,000 and falling.

If Joe filed a Chapter 13 under the old (current) law, his 60 month plan payment would look like this:

Joes Chapter 13 Plan under old (current) law

Joe's Chapter 13 Plan under old (current) law

Because of the value of the home, the second mortgage could be completely stripped away, but it does not matter.  Joe and his wife can’t afford this payment, and they will lose their home.

Under the new (proposed) law, not only will Joe be able to strip down the second mortgage, he will be able to “cram down” the balance of the first mortgage to the fair market value of $310,000.

The reduced first mortgage will be re-amortized for a period no greater than 40 years minus age of the original loan.  Since the original loan was taken out 33 months prior to filing, the new term can be no more than 447 months, or 37 years 3 months.

This is where it gets tricky.  The debtor will pay is a fixed rate of interest, as calculated by adding a “risk factor” to the “average prime offer rate”, as published by Federal Financial Institutions Examination Council.  Well, as of this writing, I cannot find where the FFIEC has actually published the “Average Prime Offer Rate.”  The closest I can come is the Freddy Mac site for an average 30 year loan (thanks Bobby Wilbert).

The next issue is “risk factor.”  What is the appropriate “risk factor” to add to this rate?  Is it the same risk factor across the board for all debtors?  Is it based upon region or household income or a combination?

For now, let’s assume that the average prime fixed rate is 5.25% and the risk factor is .75% for an interest rate of 6%.

Under the new law, the debtor’s Chapter 13 plan would look like this:

Joes Chapter 13 plan under the new (proposed) law

Joe's Chapter 13 plan under the new (proposed) law

The new law allows the modified mortgage payment to be made outside the plan, eliminating the trustee’s administrative fee, and there would be no arrearage payment.  Assuming the old adjustable interest rate would have remained constant over the 60 month period, Joe’s plan payment is virtually cut in half by the new law!  The proposed amendment to the bankruptcy code is the difference between Joe saving his home and losing it.

Yes, there are other details in the proposed law, which will be discussed in depth by me and my colleagues at Bankruptcy Law Network.  However, this is essentially the enormous impact the proposed amendment will have, and there is no question that it will fix the foreclosure crisis.

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Chip Parker is the managing partner of Parker & DuFresne, P.A., where he represents Northeast Florida businesses and consumers facing bankruptcy, and homeowners facing foreclosure. His firm files more homeowners in the Mortgage Modification Mediation Program than any other law firm in Northeast Florida. Parker is the recipient of Jacksonville Area Legal Aid's prestigious Award for Outstanding Pro Bono Service. Mr. Parker is an active member of the National Association of Consumer Bankruptcy Attorneys and National Association of Consumer Advocates.

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