Foreclosure prevention plan collapses. Read this before you waste your time

The Wall Street Journal editors are joyous.  The Senate (as of the last day in April) has killed the revision to the bankruptcy law that would have allowed judges to “cram down” the principle on residential home mortgages (they can already do it for second homes and investment property).  This was the stick in the Obama administration’s “carrot and stick” approach to foreclosure prevention.

It has already been shown that the carrot alone does not work.  All the voluntary programs established under both Bush and Obama administrations (like project HOPE) have produced pitifully poor results.  The total number of people for whom foreclosure has been prevented is a tiny fraction of the total foreclosures.  And there could be as many as two million more foreclosures to come.

As I have said many times in these entries, without the threat of a judge who can force a cram down in the principle, the lenders are not going to do it.  And without a cram down, most people in default will not be able to afford to maintain payments.

We have argued that a cram down may be better for the lender than a foreclosure, especially when the house being foreclosed is in a neighborhood where it is likely to stay (empty) on the market for an extended period of time.  The lender has all the charges of foreclosing, plus all the charges of mainatining the home until it is sold, and in the end it will end up selling the house for much much less than the mortgage balance.

The general estimate is that the lender takes a hit of from $50,000 to $100,000 on the average foreclosure.  You’d think it would be to everyone’s interest to cram down the mortgage balance by say $50,000 and see if the homeowner could not keep the home with a new, lower mortgage balance.  But things are set up with absentee mortgage holders; and mortgages in control of service bureaus that have no incentive to avoid foreclosure and who worry about being sued by the actual  mortgage holders if they make a deal.

Here is my suggestion:  Go over your situation, maybe using one of the government sponsored free foreclosure prevention counselors available around the country.  (We have a list in our previous entry: New Foreclosure Prevention Programs: How to Get Help)

Do the mortgage numbers using a lower interest rate, but with no change in principle.  If you cannot make these numbers work in your budget without doing a cram down, think about making plans to move out and turn the house keys over to the lender.  Save everyone the pain of foreclosure.

The fact is that the lender will say they are willing to negotiate, and with a lot of effort you can get them to respond to your suggestions, but in the end they will not agree to anything that will work, and you will have wasted a lot of energy for nothing.

But do not do anything without legal advice. You are still on the hook for the balance of the mortgage after the house is eventually sold, and a lawyer may be able to show you ways to avoid this problem.  At worst, you can file bankruptcy.  Judges may not be able to cram down mortgages but they may be able to clear up balances left over.

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