ISSUE IN-DEPTH: FORECLOSURES: Bankruptcy reform will help few, hurt many

In a democracy, laws are supposed to be created that benefit the majority of the public.

Congress needs to keep that in mind when considering legislation designed to address the increasing number of people falling behind on their mortgage payments and putting themselves at risk of losing their homes to foreclosure.

However, the fact of the matter is that the Helping Families Save Their Homes in Bankruptcy Act, which would allow bankruptcy judges to unilaterally change the terms of a borrower’s mortgage contract, will benefit just a small minority of the country’s at-risk homeowners. And it will surely have a negative impact on the vast majority of America’s future home buyers and homeowners looking to refinance.

The call for bankruptcy reform that has been debated for more than a year and defeated in Congress on more than one occasion, continues to rear its ugly head. But for those of you keeping score on the issue, here are the simple facts about bankruptcy and its effect on families and the economy.

Bankruptcy is an invasive and severe process. A consumer in bankruptcy will be subjected to a federally appointed trustee who will scrutinize all expenditures during the repayment plan —- usually five years. Expenditures on everything from dining out to recreation could be put under the microscope.

Bankruptcy has a historically low rate of success. In fact, some research has shown that two-thirds of all bankruptcy repayment plans fail, meaning the family will be unable to meet the obligations of the court-ordered repayment plan and will still lose their home to foreclosure.

Let’s not forget that a bankruptcy remains on a credit report for 10 years and will impact a family’s ability to buy or rent a home in the future and can even hurt their job prospects.

And these are just the consequences to current homeowners looking to bankruptcy as a solution.

Changes to the bankruptcy code will affect future home buyers in the form of higher costs and tighter lending standards.

Why? Because lenders will be forced to build new costs into future loans in order to offset the risks associated with a possible bankruptcy proceeding down the road.

If the proposed legislation is passed, consumers can look forward to larger down payment requirements, higher fees at closing or a higher interest rate, or a combination of all three. In fact, we estimate that if you were to monetize the additional cost into just the rate, it would result in a 1 1/2 point increase in mortgage interest rates across the board.

To illustrate the point, let’s look at the effect on a $300,000 mortgage at the current interest rate of 5.25 percent for a 30-year fixed-rate mortgage. A homeowner in that situation currently pays $1,657 per month. If bankruptcy reform were to pass, rates would go to 6.75 percent, and that monthly payment jumps to $1,946 per month.

In this scenario, the payments would be $289 more per month and $3,468 more per year, or $104,040 in increased costs over the life of the loan. That’s hardly a desirable outcome in the current economy and not likely to entice new buyers into relieving the glut of unsold homes on the market.

Limited credit availability and higher down payments would be particularly damaging to those parts of the country that are suffering the biggest drops in home prices. The bottom line is that resurrecting bankruptcy cram-down during this current crisis is unproductive and runs counter to the efforts to restore confidence and liquidity to the global capital markets.

Instead, Congress should enact proposals that will stabilize the markets and help keep families in their homes without permanently damaging the real estate finance system.

The Obama administration has recently initiated a number of innovative programs designed to help lenders modify or refinance loans for borrowers who are at risk of falling behind on their mortgages so that they can keep their homes.

None of these proposals will have nearly the adverse impact on the market, or future borrowers, as bankruptcy reform. As we look to stop the current increase in foreclosures and the downward spiral of housing prices, we must not adopt policies today that will have far-reaching, negative effects on future borrowers.

> David G. Kittle is chairman of the Mortgage Bankers Association. the national association representing the real estate finance industry.