Saving Homes With a New Bankruptcy Rule

Backers call it the crucial missing tool needed to get us out of the national foreclosure morass.

Critics say it could be disastrous, pushing up interest rates on all future mortgages, even for people with excellent credit, and creating huge new losses for already-ailing banks.

Wherever you come down on the griddle-hot issue of home mortgage "cramdowns," the reality is this: Congress is poised to pass legislation empowering bankruptcy court judges to reduce the loan balances of potentially large numbers of financially distressed owners to affordable levels, and to lower their interest rates and monthly payments. President Obama has promised to sign the legislation as soon as it hits his desk.

Cramdown may be an unpleasant sounding word, but for decades it's been part of the bankruptcy lexicon for most types of debt. If you file for Chapter 13 bankruptcy -- a court-supervised, multiyear workout plan designed to provide at least partial repayments to your creditors -- judges can reduce what you owe on credit cards; auto, boat and student loans; and even second-home mortgages. But under current law they cannot cut the mortgage debt you owe on your principal residence.

That, in turn, allows lenders to foreclose on delinquent homeowners to force quick recovery of what they're owed -- part of the reason why foreclosures are so numerous.

For two years, Democratic leaders in the House and Senate have been pushing for a change in the bankruptcy law to include principal residence loans on the list of debts that can be "judicially modified" -- crammed down -- by the courts. They argued that banks and mortgage companies too often have been unwilling to offer delinquent borrowers serious modifications on loans because they have the option to pull the plug and foreclose.

Lending industry groups blocked those bills by appealing to Republican allies, especially in the Senate. But in the wake of the November elections, Democratic majorities are now large enough to almost guarantee passage of cramdown legislation, maybe as early as this month.

Though final details will depend on conference negotiations between the House and Senate, it's likely the legislation will provide that:

· Only mortgages closed before the date of enactment will be eligible for cramdown protection. In other words, the focus will be on helping current owners, rather than future borrowers who become delinquent.

· To be eligible, owners will need to inform their lender or loan servicer in advance of their intention to file for bankruptcy protection. That's intended to get the lender's immediate attention and prompt its best offer on a modification of the loan terms, including principal reduction.