House Democratic members from North Carolina and California, respectively, recently propose legislation that would repeal the mortgage exception in the federal bankruptcy code.

This legislation would allow a judge to change the priority value of primary residence mortgages or alter interest rates on the property. In the current economic climate, industry insiders are predicting over half a million foreclosures in the next 24 months, prompting serious discussions around this issue.

What is Bankruptcy?

There are two main types of Bankruptcy options for the consumer. Chapter 7 Bankruptcy is often referred to as a "liquidation bankruptcy." In Chapter 7, all of the debtor's assets, other than those specifically exempt from liquidation, are turned over to a bankruptcy trustee for sale.

Chapter 7 Bankruptcy is used to eliminate, or discharge primarily unsecured debts such as credit cards or medical bills. Chapter 7 does not eliminate secured debts, such as vehicles. Chapter 7 will not save houses from foreclosure or a car from repossession if payments are delinquent.

Chapter 13 Bankruptcy, most commonly used to halt a foreclosure, results in a plan to repay all or part of a debt. Many times a debtor is allowed to pay credit cards and medical bills at pennies on the dollar. Chapter 13 is used most often to save a house from a foreclosure sale or vehicle from repossession. Chapter 13 is also useful to eliminate some IRS debt and to establish an affordable plan to pay IRS debt that cannot be eliminated. Chapter 13 Bankruptcy is available to debtors with regular income.

The bill before the house, entitled the Emergency Home Ownership and Mortgage Equity Protection Act, would give a bankruptcy judge the option of restructuring the amount an in debt person owes on the mortgage on a primary residence so that only the portion of the loan principal that doesn't exceed the market value of the property would receive high priority.

In other words, "the portion of the mortgage principal that exceeds the market value of the home would be treated as an unsecured liability, as in Chapter 7, and not given preferential treatment, meaning that the amount could be discharged in a bankruptcy proceeding.
Traditionally mortgage payments on primary residences, like tax liabilities, have been sacred untouchable territory in bankruptcy negotiations, not allowed to be tampered with by the courts.

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