There's a very educational article at Consumer Affairs about the need of bankruptcy reform to save hundreds of thousands of homeowners struggling to pay subprime mortgage loans and facing imminent foreclosure.
Consumer groups quoted in the article said:
"The only chance many of these (subprime) borrowers have is through declaring bankruptcy...the problem is that as currently enacted, the Bankruptcy Code favors home mortgage lenders over virtually all other secured and unsecured creditors. The amendment disfavoring protection of the debtor's principal residence was added at a time -- 1978 -- when home mortgages were nearly all fixed-interest rate instruments with low loan-to-value ratios and were rarely themselves the source of a family's financial distress. As a result, bankruptcy law singled out the home mortgage loan as the major debt for which the bankruptcy court is powerless to provide relief...Since that time, the mortgage market has shifted considerably. Subprime lending practices of the last six years, which have relied on property appreciation, and in many cases appraisal fraud, have left many borrowers with mortgages larger than the value of their homes. If the borrowers cannot restructure these debts, then they cannot get back on their feet financially."
This statement sums up the foreclosure challenge perfectly. The mortgage loan companies have relied on adjustable rate mortgages and the belief that home values would continue to rise to make a profit in the housing boom. Many subprime borrowers took out adjustable rate mortgage loans because they believed that the value of their home would rise by the time the rate adjusted and they could sell the home and make a profit or refinance.
Unfortunately, as we all know that didn't work out and now many subprime borrowers who believed they were investing in an appreciating asset find themselves drowning in mortgage debt and facing foreclosure as their home values drop and their mortgage rates increase drastically. The bankruptcy laws enacted to protect mortgage lenders are currently serving as a disincentive for mortgage lenders to fix the current foreclosure crisis. Bankruptcy courts need to be given the power to examine these toxic loans and modify them when appropriate.