Should Chapter 13 plans allow mortgage strip-downs? Pt.2

The working paper from Federal Reserve Bank of Philadelphia suggests that the bad effects of allowing mortgage strip-downs or cram-downs in Chapter 13 would not be as significant or adverse as the banking industry suggests.

In the 1980s, some Circuit Courts of Appeal permitted this practice and the researchers at the Federal Reserve examined the response of mortgage markets to these decisions. They concluded that the market responses are “small and not always in predicted direction.”

One possible explanation why this may be is the reality of the realty market. The definition of a market transaction is the price a willing buyer pays a willing seller. A cram-down or strip-down of a mortgage during a Chapter 13 is little more than recognition of the reality of the change in market conditions.

Here’s why the potential affect on the mortgage market is limited. If an underwater borrower goes into foreclosure, they abandon the property and the lender has to accept the legal transaction costs of the jurisdiction’s foreclosure procedure.

They may have to hire a Tennessee attorney to process the foreclosure and ensure that it complies with state law, which can vary greatly from state to state.

During this time, they have to assume actual ownership of the property, instead of relying on the borrower to insure and maintain the property. They may have to expend additional financial resources to repair or modify the property to make it ready for sale.

And then they have to actually sell the foreclosed property at whatever the market value at that time happens to be for foreclosed properties in that area. This is likely to be far below the remaining loan balance of the mortgage.

More on this in our next post.

Housingwire.com, “Philadelphia Fed: Could principal reduction save bankrupt homeowners?” Brena Swanson, December 3, 2014

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