The House of Representatives passed a sweeping financial reform bill Friday, but failed to approve an amendment that would have allowed bankruptcy judges to renegotiate mortgages of homeowners filing Chapter 13 bankruptcy.

Mortgages in Bankruptcy

Under current bankruptcy law, some filers can prevent or postpone mortgage foreclosure by filing for Chapter 13 bankruptcy. Here’s what Chapter 13 can and cannot do:

• It CAN give a filer breathing room: When you file a bankruptcy petition, an automatic stay takes effect and prevents any of your creditors from contacting you or repossessing your property. This includes mortgage lenders. The stay remains in effect for the duration of the bankruptcy case, which, in Chapter 13 cases, generally means three to five years
• It CAN give a filer a chance to catch up on debts: By making payments in a three- to five-year repayment plan, Chapter 13 filers can catch up on many of their secured debts. The repayment plan restructures debts, which often means filers can reorganize their finances to make mortgage payments.
• It CANNOT change the terms of a filer’s mortgage: While other debts may be restructured, reduced or even forgiven by the bankruptcy court, mortgage loans for primary residences cannot. This provision was put in place initially to promote homeownership: mortgages that were difficult to get out of meant lenders had greater security and so could charge lower interest rates, thus making home loans available to more Americans.

The Bill

The mortgage modification plan being considered was an amendment to a sweeping reform bill aimed at preventing another financial meltdown. And amendment proposed would have given homeowners the change to restructure the terms of their mortgages in bankruptcy with the goal of preventing foreclosures. The bankruptcy amendment would have allowed judges in personal bankruptcy cases to modify mortgages in the following ways:

• Lower interest rates
• Lengthen repayment terms
• Cut the total amount due

Changes like these are known as cram downs and are often cited as one of the only ways for under-water borrowers to get on top of their home loans again. While they may provide relief to struggling homeowners, they could mean bad news for lenders and investors in mortgage-backed securities.

An identical bankruptcy reform bill passed in the House earlier this year but never completed its route through the Senate. This time around, the legislation didn’t even make it past the House, facing rejecting by a vote of 241-188.

Representative Barney Frank (D, Mass.), House Financial Services Committee Chairman, reportedly supported the bill, which would be available to homeowners who met the eligibility standards of the Home Affordable Modification Program.

Additional Resources

Home Affordable Modification Program (PDF)