Philadelphia Fed: Could principal reduction save bankrupt homeowners?

Back in 2009, mortgage lenders shot down proposed legislation by the Obama Administration to allow strip-down of residential mortgages for homeowners in Chapter 13 bankruptcy due to the adverse effects that it would have.

Now five years later, the Federal Reserve Bank of Philadelphia is arguing that lenders were wrong.

A mortgage strip-down reduces the principal of underwater residential mortgages to the current market value of the property for homeowners in Chapter 7 or Chapter 13 bankruptcy. If a bankruptcy judge is granted mortgage modification powers, than it stands to reason an interest deduction could be implemented on top of the principal reduction.

The legislation was proposed in 2009 as a means of reducing foreclosures during the recent mortgage crisis.  And according to a new paper from the research department with the Philadelphia Fed, introducing mortgage strip-downs would not have strong adverse effects on mortgage loan terms and could be a useful new policy tool to reduce foreclosures.

The paper titled, “Using Bankruptcy to Reduce Foreclosures: Does Strip-Down of Mortgages Affect the supply of Mortgage Credit?” sought to determine whether allowing bankruptcy judges to modify mortgages would have a large adverse impact on new mortgage applicants.

Read on.

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