Mortgage Watch: Obama Redesigns the Cram-Down

RescueGranted, “cram-down” is not the most delicate term, but it does convey the sentiment that lenders feel at the thought of being forced to write down the principal on a home loan.

Cram-down applies to bankrupcty cases. It refers to the court’s power to allow a debtor to restructure loans, including lowering the principal to the fair market value.

These provisions help spread more of the debtor’s money to the creditors as a whole, and get debtors back on their feet. With a couple rare exceptions, cram-downs have not been available for loans on a principal residence. The new plan changes all of that.

Obama outlined this plan on Wednesday and described it as a life raft to assist homeowners who “have no other options available to them.” If he’s right, the new cram-down option will stall some foreclosures, which he says will “help everyone”, referring to a statistic that a neighborhood loses $6,000 in home values with every foreclosure.

The Center for Responsible Lending agrees that the plan will slow foreclosures, and thereby save tax dollars dedicated to that purpose.

Many fear, though, that offering cram-downs on primary homes will have a far-reaching impact on mortgages. First, the losses that lenders face are likely to force mortgage costs and rates up, and financing will grow out of reach for some buyers. The plan may also scare away investors from mortgage-backed securities because those become more volatile.

The end result will depend largely on whether there is a sudden increase in bankrutpcy filings. While some feel a flood of bankruptcies is an inevitable next step in the economic crisis, new amendments to the Bankruptcy Code have made the option less viable for many debtors.

Still, Obama promises a couple of safeguards to minimize the damage to the mortgage industry:

  • The cram-down will apply only to existing Fannie Mae and Freddie Mac conforming loans, and
  • Debtors will have to show documentation proving that they asked the lender for a loan modification that could have kept them in their house, but were denied.

Obama admits that, in this sense, the cram-down is really a ‘stick’ to hold over lenders to entice them to modify loans voluntarily so that debtors don’t have to file bankruptcy and endure even more damage to their credit.

But he warns that this plan is not intended to help investors. “The emphasis is on familiies, not someone who thought they could buy low, watch the prices rise 10-20-40%, and then sell.”

See our feature, Apartment Industry Applauds New Obama Plan.

See other articles on Real Estate Financing.

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