Cramdowns Increase Costs for Homeowners
Mr. Chairman, we all agree on the same goals. We all want to help consumers by stabilizing the market. We want to help families stay in their homes and we want to make sure that the market excesses we saw earlier in this decade do not return. We all agree on that.
We disagree on the notion that bankruptcy would help our nation's consumers. We should be working on efforts to keep people out of the bankruptcy courts, rather than pushing people toward them. Let me give you three reasons why bankruptcy is harmful to consumers.
First, no one should make filing for bankruptcy appear attractive. There are real and severe consequences for consumers who declare bankruptcy. Bankruptcy stays on a credit report for seven to 10 years. It makes it very difficult to acquire future credit for a new home or car. It can stand in the way of getting insurance. It can make it harder to get a new job or even to rent a home or an apartment.
Two-thirds of those people who file for bankruptcy are unable to fulfill the terms of their repayments plans. Two-thirds. In other words, two-thirds of those who file will still lose their home, and still have the bankruptcy on their record.
Second, changing the law will force lenders to impose tougher standards on people trying to get a mortgage. "Cramdown" legislation would add new risks to the calculation lenders make in setting prices. For the first time, lenders will have to pay more attention to markets with the most volatility and those with higher risks, such as rural areas, inner cities and new subdivisions, where history shows the greatest fluctuation of home values. This could even lead to a new era of redlining.
Lenders would be forced to demand larger downpayments and raise interest rates to balance the risk from judges who could change the mortgage contract and cause lenders or investors to suffer an economic loss.
Third, as you know, our financial markets are incredibly fragile right now. Cramdown legislation will only add more instability. The only option for many low-income borrowers today is to get an FHA-insured loan, where the government minimizes the risk to the lender of making a low-down payment loan. Cramdown legislation would make it harder for borrowers to get an FHA loan, because lenders would face the possibility that FHA insurance would not cover the loss from principal reduction. The same is true for VA lending. In effect, Congress would end the only meaningful lending option currently available to most low-income borrowers - almost overnight. Throughout this debate, I have heard again and again about why bankruptcy laws should be changed, the idea that rich people with vacation homes get cramdown protection and that the middle class is somehow being cheated out of this protection.
Let me clarify how current law works. If someone in bankruptcy were to have a $400,000 mortgage on a vacation property and the judge were to reduce that to $350,000, the debtor would be required to pay off the entire $350,000 in equal monthly payments during the three- to five-year repayment plan, not over the course of 30 or even 40 years. More likely, the judge would force the debtor to sell the vacation home.
Vacation home customers pay for this added risk in four ways, significantly higher downpayments, higher interest rates, higher origination fees and shorter, more expensive loan terms. Future homebuyers can expect to see similar treatment if Congress passes cramdown legislation. In 1978, this committee passed a broad rewrite of the bankruptcy code. It specifically and purposefully excluded primary residences from cramdown. Congress did so to keep the costs of primary residence mortgages low. This is not a loophole. This was an important effort by Congress to encourage homeownership, which even today, is the best way for American families to build, grow and maintain wealth.
Congress should continue to help consumers by keeping mortgage costs low. Passing cramdown legislation during this credit crunch will further destabilize the mortgage market.