McLeod Law Offices

There’s been some press about a proposed change to chapter 13 that would permit debtors to modify the mortgages on their primary residence. Yesterday, I attended the briefing at the State House given by Rep. William Delahunt where the need for the legislation was discussed. He has co-sponsored a bill that would modify the anti-modification restrictions imposed by Section 1322(b)(2). Among the presenters were Massachusetts Attorney General Martha Coakley, Secretary of State William Galvin, and Harvard Law Professor Elizabeth Warren.

Currently, a chapter 13 debtor cannot modify the mortgage on their home if the note is secured by the debtor’s primary residence. This does not apply if the debtor has a multi-family dwelling, such as a two-family. This does not apply if the note is secured by the house and other property (although this may vary from state to state). This also does not apply if a debtor has a vacation home or other investment property. It applies only to those chapter 13 debtors who reside in single family homes and who have a mortgage that is secured by that single family home that they use as a primary residence.

Notwithstanding those restrictions, a chapter 13 debtor may “strip off” a second mortgage (or in some cases, a third), if the mortgage is “wholly unsecured.” A simple illustration: if the value of the property is so low that if the property were sold, there would not be funds to pay the second or third mortgage. However, if that second or third mortgage is secured by even a penny, it cannot be stripped off.

The Boston Herald quoted Kevin Cuff, Executive Director of the Massachusetts Mortgage Banks Association:

You’re opening up a Pandora’s box, a precedent to haul every mortgage back into court…Many people who got these loans should not have received them in the first place. Now you go to the courts to modify the sacred contract between homeowner and lender? It’s socialized housing.

I might agree with that position if chapter 13 debtors could not modify their vacation homes or investment properties. I might agree with that if city dwellers who reside in a unit in their multi-family home could not modify their vacation homes. But that’s not the case. The current system has a disparate impact on those chapter 13 debtors who reside in single family homes, and those who do not, and for many, those who do not reside in non-urban/rural areas. It also has a disparate impact on those middle-class debtors who do not have vacation homes or investment properties.

In addition, the legislation is being proposed because voluntary modifications are not happening. It is argued that if there is a “threat” of filing bankruptcy and modifying a mortgage in chapter 13, the lender may be more apt to modify the loan voluntarily so that the homeowner does not need to file chapter 13. It sounds like a good argument, but I honestly cannot say one way or another whether that would be the case. Of course, if the law were passed, then it would be really up to the lender to decide if they wanted to be hauled into court to be forced into a modification. The only way I think any of us can know for sure is if we give it a try. But before anyone makes a decision one way or another on this proposal, I think it’s important to know what the law currently provides, and why I do not think it is necessarily a “Pandora’s box” or “socialized housing.”