United States bankruptcy laws specifically prohibit modifications of primary mortgages for those in bankruptcy court, even when filers are in danger of losing their homes to foreclosure. Despite those restrictions, some news sources have reported that judges in certain parts of the country (primarily California, Louisiana and Texas) have been doing just that for filers.

What Is a Mortgage Cram-Down?

In bankruptcy court, a mortgage cram-down works like this:

  • A filer submits a bankruptcy petition. This filer must have a mortgage loan (so that the court has something to cram down). According to current law, only secondary mortgages (including those for business properties or vacation homes and second mortgages on primary residences) are eligible for cram-down in court.
  • The judge decides to grant a cram-down. When this happens, the principal amount of a borrower’s loan is reduced (usually to the property’s current fair-market value). To repay the loan, the borrower then only has to repay the crammed down amount.
  • The borrower continues making payments. Ideally, the crammed down mortgage proves more manageable and the borrower/bankruptcy filer is able to continue making mortgage payments and thus avoid foreclosure.

Why Aren’t Mortgage Cram-Downs Legal?

At the time the anti-cram-down legislation was first written, legislators and industry insiders wanted to encourage homeownership among Americans. Making a mortgage loan impossible to modify in bankruptcy meant that:

  • borrowers would have few chances to get out of loans, so
  • lenders would be almost guaranteed repayment of any loans they issued, so
  • interest rates could be kept lower, which would mean
  • more people would have access to homes.

Why Are Some Judges Offering Cram-Downs Anyway?

While sources are not clear on why certain judges have elected to begin cramming down mortgages despite laws prohibiting mortgage modifications, one answer seems clear: people need cram-downs. And some judges may see the move as retaliatory against unscrupulous lenders that initiated risky loans during the housing boom.

In fact, mortgage distress has become so common among American homeowners (some estimates suggest that as many as 28 percent of homeowners are underwater on their loans) that Congress even considered passing a law in 2009 that would have permitted primary mortgage cram-downs in bankruptcy.

What Will Happen with Cram-Downs in Bankruptcy?

While it’s impossible to predict the exact future of cram-downs in bankruptcy, some insiders suggest that, as word gets out that cram-downs are becoming more common in some courts, they will gain popularity elsewhere.

Others suggest that, if word gets out (so to speak) bankruptcy filings might pick up in coming months and more Americans might be helped with their primary mortgage woes with quasi-legal cram-downs.

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