Mortgage Modification, Equitable Subordination, and the Honest but Unfortunate Creditor
66 Pages Posted: 30 Mar 2010 Last revised: 3 Apr 2011
Date Written: October 26, 2010
Abstract
Mortgage foreclosures are at an all-time high and property values in many parts of the country have declined precipitously. Yet bankruptcy, which is often a last resort for individuals in financial distress, provides little relief to a homeowner who finds that her mortgage debt exceeds the value of her home. The reason for bankruptcy’s inadequacy in this regard is the Bankruptcy Code’s prohibition on the modification of home mortgages, a prohibition that became part of bankruptcy law in 1978, when most home mortgage loans were 30-year fixed rate loans made by savings and loan associations. While most secured loans can be stripped down in bankruptcy, reflecting the payment that the lender would receive if it were forced to foreclose on the collateral, a home mortgage loan must be paid in full, giving the lender more than it would receive under state law.
In recent years, abusive mortgage practices have proliferated. These abusive practices, which have prevented homeowners from building equity in their homes, harm not only the debtor, but also the debtor’s other creditors. Despite their behavior, however, home mortgage lenders who engage in these practices continue to receive favorable treatment in bankruptcy. In this paper, I argue that creditors should be denied special treatment in bankruptcy unless they behave in an “honest but unfortunate” manner. Judges can deny this special treatment by using a time-honored bankruptcy principle, the principle of equitable subordination, to subordinate the unsecured portion of a home mortgage loan to all secured and priority claims. While equitable subordination, by itself, will not solve the foreclosure crisis, it may, by reducing the claims of abusive mortgagees, deter abusive lending practices in the future.
Keywords: mortgage modification, equitable subordination, chapter 13 Bankruptcy, subprime lending
JEL Classification: K1, K11
Suggested Citation: Suggested Citation
Do you have a job opening that you would like to promote on SSRN?
Recommended Papers
-
Personal Bankruptcy and the Level of Entrepreneurial Activity
By Wei Fan and Michelle J. White
-
Personal Bankruptcy and the Level of Entrepreneurial Activity
By Wei Fan and Michelle J. White
-
Determinants of the Consumer Bankruptcy Decision
By Ian Domowitz and Robert Sartain
-
Bankruptcy Exemptions and the Market for Mortgage Loans
By Richard M. Hynes and Jeremy Berkowitz
-
Bankruptcy and the Market for Mortgage and Home Improvement Loans
By Emily Y. Lin and Michelle J. White
-
An Optimal Personal Bankruptcy Procedure and Proposed Reforms
By Hung-jen Wang and Michelle J. White
-
Bankruptcy Law and Entrepreneurship
By John Armour and Douglas J. Cumming