Help for Homeowners May Be on the Way

Two years into the housing crisis and several widely-criticized bailout plans later, struggling homeowners may finally be getting some real help.

The good news came from an unexpected source Thursday, when one of the nation's largest lenders, Citigroup (C), announced its support for legislation that would allow consumers in Chapter 13 bankruptcy repayment plans to get their mortgages modified. These modifications, also known as "cram downs," would involve both a reduction of the interest rate and, if the homeowner is underwater on their mortgage, an adjustment of the loan principal down to the home's current market value.

"This is the only program that gives homeowners actual rights, and therefore leverage, negotiating with their lenders," says Henry Sommer, a bankruptcy attorney in Philadelphia and director with the National Association of Consumer Bankruptcy Attorneys.

Although the plan directly affects only homeowners filing for Chapter 13 bankruptcy protection, consumer advocates and bankruptcy attorneys hope that the legislation -- if it becomes law -- would prod lenders to offer the same type of cram downs to all troubled homeowners.

"The hope is that when the mortgage companies understand that if they don't do anything, the person will file bankruptcy and get this relief, they'll offer them something reasonable," Sommer says.

Previous bailout plans encouraged the mortgage industry to modify troubled loans, but they often had questionable results. While loan modifications increased last year, 55% of these loans were 30 or more days delinquent just six months later, according to an Office of the Comptroller of the Currency (OCC) report. The problem? Many of the modifications rarely resulted in an affordable mortgage payment, explains John Rao, an attorney with the National Consumer Law Center, an advocacy group.

In fact, an alarming 45% of modifications actually increased the homeowner's monthly payment, while 20% left the payment the same, according to a report published in November 2008 by Alan White, assistant professor of law at Valparaiso University.

So what are the chances of this legislation becoming law? There were several unsuccessful attempts to pass this bill last year, most recently as part of the Emergency Economic Stabilization Act of 2008, more well known as the $700 billion bailout. But now that that a major lender is behind it -- and others may soon follow, Rao says the chances it will be signed into law are pretty good. He thinks it could happen as soon as President-elect Obama takes office.

There is one possible blockade, however. The Mortgage Bankers Association continues to oppose the bill. “We remain opposed to bankruptcy cram down legislation because of the destabilizing effect it will have on an already turbulent mortgage market," said John A. Courson, president and CEO, and David G. Kittle, CMB chairman in a statement.

How the "cram down" legislation will help homeowners:

1. Encourage lenders to do more loan modifications in order to keep homeowners out of the bankruptcy courts. Effectively, give borrowers leverage in negotiating with their mortgage servicer or lender.

2. Improve the quality of loan modifications, including a reduction in mortgage principal to reflect the current market value of the home. This may result in fewer homeowners walking away from their homes.

3. Improve the likelihood that Chapter 13 bankruptcy filers get to keep their homes. Currently, as judges do not have the right to modify mortgage loans on primary residences, many homeowners who file for bankruptcy protection in order to avoid foreclosure fall behind on their payments. Then, the mortgage company gets permission from the courts to foreclose anyway.