The New York Times-20080127-What Do -Cram-Downs- Cost-

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What Do 'Cram-Downs' Cost?

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PENDING bankruptcy legislation is something few homeowners pay attention to, but when the industry's leading trade group suggests that the prospective law could cost new borrowers $200 a month or more, it is hard to ignore.

The legislation in question is the Emergency Home Ownership Mortgage Equity Protection Act of 2007, which the House of Representatives' Judiciary Committee passed last month. Under the proposal, bankruptcy judges would be permitted to change the terms of a mortgage and allow borrowers to repay only part of the loan.

The legality of this practice, known as a cram-down in industry parlance, has been in question for years, and cram-downs have been used sparingly.

But mortgage bankers contend that if Congress condones cram-downs, lenders will have less faith in the underlying value of the mortgage, and they will have to charge interest rates about 1.5 percentage points higher on all mortgages to offset the risk of future cram-downs.

The Mortgage Bankers Association, based in Washington, said borrowers buying a middle-class home in New York State would pay about $250 more per month if the legislation passed. If this proposal becomes law, it will amount to a new tax on New York homeowners, David Kittle, the mortgage bankers' chairman-elect, said in a prepared statement.

Using 2006 data from New York as an example, the mortgage bankers' group said that an increase of 1.5 percentage points in the interest rate on the average loan amount, $250,000, would cost New York borrowers about $2,990 annually. New Jersey borrowers with an average mortgage would pay $2,875 more annually, and Connecticut borrowers would pay $2,636 more.

In explaining the predicted effects of cram-downs to Congress, Mr. Kittle made a multifaceted argument.

Among other things, he said that current bankruptcy laws allow cram-downs for mortgages on vacation homes, investment properties and other houses that are not the borrower's principal residence. The interest rates charged for those properties, he said, are typically three-eighths of a percentage point higher than rates on mortgages that cannot be modified by bankruptcy judges.

Not everyone accepts the Mortgage Bankers Association's math, however. The M.B.A.'s number is kind of hokum, said Adam J. Levitin, who teaches bankruptcy law at Georgetown University. After recently analyzing loan data from 1978 to 1993, he found that interest rates did not rise in areas where cram-downs were common.

I'm trying to figure out why the mortgage industry is so opposed to this reform, Mr. Levitin said, because it won't result in huge losses for them.

When briefed on Mr. Levitin's arguments, John Mechem, a spokesman for the Mortgage Bankers Association, said in an e-mail response, In the end, consumers will bear the brunt of this legislation in the form of higher costs and/or tighter credit.

Craig Focardi, an analyst with the TowerGroup, a financial-services consultancy in Needham, Mass., agreed that lenders would incur greater losses on loans if cram-downs were permitted.

But I doubt the M.B.A.'s number, he said. It's not the way lenders price loans. They don't say, 'Hey, let's add the cram-down pricing add-on of 1.5 percent!' If I were to guess at additional financing cost for new borrowers resulting from cram-downs on defaulted loans from existing borrowers, it might be $5 to $10 per month.

[Illustration]CHART: INDEX FOR ADJUSTABLE RATE MORTGAGES: 1-year Treasury rate (Source: HSH Associates) Chart shows two line graphs and an outline for adjustable rate mortgages.