Congress takes up foreclosure relief plans

Now, as Congress prepares to authorize the second $350 billion in spending for the program, Democratic leaders are pressing for changes that would expand beyond the banking industry, which has been the primary beneficiary of the program. A House Committee heard testimony Tuesday on revisions that would commit between $40 billion and $100 billion of TARP funds to various foreclosure relief measures.

One proposal would expand an FDIC program aimed at standardizing the loan modification process and paying mortgage servicers a fee for every loan they modify. To cap monthly payments at no more than 31 percent of a borrower’s income, loan servicers could extend the loan to 40 years or defer some interest until the borrower sells or refinances their home. The measure would also provide mortgage servicers some protection against investor lawsuits claiming a loan modification lowered their returns.

The TARP revision also could include changes to the Hope for Homeowners program, which provided $300 billion in guarantees to help lenders refinance troubled borrowers into FHA mortgages. Lenders balked because the program was too costly; changes in the law are expected to make the plan more attractive.

Congress also is considering various proposals as part of a planned $800 billion economic stimulus program, including tax cuts promoted by the home building industry for home buyers. That could include tax credits for all homebuyers, not just first-timers, of $7,500 or more. Mortgage interest would be deductible even for taxpayers who don't itemize; tax incentives may also be given to owners who rent out vacant properties.

The most controversial foreclosure relief proposal — and the biggest "stick" being considered — involves changing the bankruptcy law to allow courts to modify terms of first mortgages on primary residences. (Those are the only form of debt currently excluded from the bankruptcy process.)

First proposed over a year ago, the latest proposal would require borrowers to contact their mortgage lender 10 days before filing for bankruptcy to give the two sides time to work out a modification. If the lender doesn’t make an offer, a judge could then adjust the loan balance to fair market value, cut the interest rate and extend the loan as part of a court-ordered five-year payment plan. There’s no guarantee, however, that a foreclosure could be prevented if the mortgage balance greatly exceeds the homeowner's ability to pay it down.

This so-called "cram-down” provision is strenuously opposed by the lending industry, which argues that the new risk that a loan will later be modified by a judge will increase the cost of borrowing.  Some financial analysts caution the move could also make mortgages harder to finance.

“Investors outside the U.S. will now view the U.S. mortgage market as riskier and therefore they may be willing to commit less capital to it,” said Jaret Seiberg, an analyst with the Stanford Group.

But that view is disputed by some economists. Adam Levitin, a professor at Georgetown University Law Center, say his research comparing mortgages on single-family homes, which are excluded from bankruptcy court revisions, and multifamily homes, which aren’t, showed the difference in interest costs amounted to a fraction of a percentage point.

“There was a statistically significant impact, but it was small,” he said. “I would expect to see that impact borne by the highest-risk borrowers, and that’s very good policy. It would inject a little prudence into the mortgage lending process.”

Though it was defeated twice in the last Congress, the measure got a major boost last week when Citigroup agreed to support the proposal, with some modifications. (One key change would restrict the provision to existing mortgages, preserving the bankruptcy exemption for new first mortgages.) The National Association of Home Builders, also a staunch opponent last year, has signaled it would consider supporting some form of the provision.

Congress also is looking at additional measures aimed at reducing mortgage rates to spur home buying, including providing an explicit government guarantee and raising limits on conforming loans issued by Freddie Mac and Fannie Mae. But those measures offer little relief to the roughly one in six homeowners whose home’s value has fallen below their mortgage balance.

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