-- To be eligible, owners will need to inform their lender or loan servicer in advance of their intention to file for bankruptcy protection. That's intended to get the lender's immediate attention and prompt its best offer on a modification of the their loan terms, including principal reduction.
-- Should the value of the borrowers' home increase, any appreciation would be shared with the lender under a pre-set formula.
Though banking groups predict that huge numbers of delinquent homeowners will opt for bankruptcy to avoid foreclosure, some consumer advocates say those fears are overblown.
"This is not going to be a cakewalk" for owners seeking protection of the courts, said David Berenbaum, executive vice president of the National Community Reinvestment Coalition. Owners will need to hire a lawyer and petition for Chapter 13 bankruptcy. Then they'll be required to follow a detailed bankruptcy court-ordered household spending plan, monitored by a trustee, for a period of years. Finally, their credit scores and ability to borrow will be severely affected for seven to 10 years.
"This should only be a last resort" for homeowners, said Berenbaum, not anybody's first choice.
Though resigned to the probability that some form of mortgage cramdown will be enacted, financial industry leaders continue to warn of dire consequences. Allowing "judges to unilaterally change mortgage contracts will increase costs for all future borrowers in the form of higher rates, greater fees and larger down payment requirements," said Steve O'Connor, senior vice president of government affairs for the Mortgage Bankers Association.
Cramdown advocates answer that lenders are blowing smoke about rate hikes, and that there is no statistical evidence that rates increase when consumers get the right to file for bankruptcy protection on a particular type of debt.
The best possible scenario coming out this whole controversy: that lenders and delinquent borrowers begin talking about serious modifications far earlier in the process than they've done so far. That way fewer people have to file for bankruptcy, fewer lenders get crammed down, and fewer people lose their houses.