Proposals for dealing with the foreclosure crisis frequently include allowing bankruptcy judges in Chapter 13 cases to modify residential mortgages to bring them in line with the actual value of the debtors' homes, and, where appropriate, reduce the interest rate. This would often result in substantially reduced mortgage payments. At present, only non-residential mortgages can be modified in Chapter 13 bankruptcy.
While this approach to mortgage-debt relief seems helpful on the surface, it has one important flaw. A large number of people facing foreclosure are unable to propose feasible Chapter 13 plans that would be a prerequisite for the proposed relief. Proposals for mortgage debt relief in bankruptcy should include Chapter 7 bankruptcy as well as Chapter 13 bankruptcy.
It of course makes sense to use Chapter 13 as the vehicle for residential mortgage modifications -- Chapter 13 already allows for modification of other types of secured debts, and provides for amortization of mortgage arrears over the life of the plan. However, to extend the relief to the many debtors who can't use Chapter 13, Chapter 7 bankruptcy judges should also be authorized to modify mortgages and interest rates, and fold any arrearages into the newly modified mortgages. This will permit debtors to emerge from Chapter 7 with their home ownership intact, and reap the benefits of lower mortgage payments as part of their fresh start.
Not every person or family would be eligible for this relief. The bankruptcy judge would determine whether the debtor could afford the modified mortgage after bankruptcy. This determination would be based on the debtor's income, income history, and other expenses. If the judge decides that the mortgage would cause the debtor undue hardship or interfere with the debtor's fresh start, the mortgage would remain as is, and the creditor would be given a green light to proceed with the foreclosure. Importantly, this is the same procedure as is already used in in Chapter 7 "discharge hearings" when self-represented debtors seek to reaffirm car notes and other secured debts.
Perhaps using Chapter 7 as well as Chapter 13 bankruptcy for mortgage modifications doesn't go far enough. Maybe a special federal court procedure should be set up where anyone facing foreclosure can apply for relief without having to file any type of bankruptcy. There may be constitutional impediments to modifying mortgages outside of bankruptcy, but, if not, it would be wonderful to have a universal procedure for residential mortgage relief, at least from the standpoint of the millions of borrowers subject to predatory loans and flat-out unaffordable mortgages.