By the time the lender has completed all of the necessary steps required to foreclose and sell a property, they are likely to have lost a substantial portion of their loan value. This means, in reality, if they had accepted a principal reduction from a borrower in a Chapter 13, at the end of the day, they may not be economically any worse off and may actually be better off.
The real estate crisis of the last decade was different from previous examples of real estate speculation gone bad, because it affected the entire country and caused a major recession. This drove millions of mortgages underwater and into foreclosure. While lenders will object “on principal” to allowing principle reductions on mortgage loans, it presents little threat to their overall profitability during most economic cycles.
This is because real estate in the U.S., when it is not driven by a speculative bubble, tends to appreciate and very rarely loses value. For the average debtor in a Chapter 13, a “strip-down” to the market value of the property would almost never produce a reduction in what they owe, as typically their property will have increased in value during their time of possession.
The other factor that supports the use of principal reductions in many existing mortgages is that they were based on speculative pricing during the time of the real estate bubble, and that it was the banks and other lending institutions behavior that fostered this speculation.
In essence, the banks should not be rewarded by being allowed to maintain a secured interest in a property that was greatly overvalued when it was purchased, and whose mortgage was based on that valuation, which was driven by their lending conduct.
Next time we will look at the motivation behind why they did this.
Housingwire.com, “Philadelphia Fed: Could principal reduction save bankrupt homeowners?” Brena Swanson, December 3, 2014
