The Primary Residence Exception: Legislative Proposals in the 110th Congress to Amend Section 1322(b)(2) of the Bankruptcy Code
Order Code RS22755
Updated November 19, 2007
The Primary Residence Exception:
Legislative Proposals in the 110th Congress
to Amend Section 1322(b)(2) of
the Bankruptcy Code
David H. Carpenter
Legislative Attorney
American Law Division
Summary
The recent downturn in the housing market has likely played a role in the rise of
late mortgage payments and foreclosures occurring across the country. Some in
Congress expect it will lead to increased filings for bankruptcy. As a result, at least four
bills seeking to amend § 1322 of Chapter 13 of the Bankruptcy Code have been
introduced in the 110th Congress. These bills are S. 2133 and H.R. 3778 (the Home
Owners’ Mortgage and Equity Savings Act, or HOMES Act); S. 2136 (the Helping
Families Save Their Homes in Bankruptcy Act of 2007); and H.R. 3609 (the Emergency
Home Ownership and Mortgage Equity Protection Act). This report provides an
overview of the general Chapter 13 process and analyzes how these four bills seek to
amend Chapter 13.
Mortgage Market Backdrop
Subprime mortgages are loans extended to borrowers who have no credit history, a
blemished credit history, and/or a weak debt-service-to-income ratio. The subprime
mortgage market began to flourish in the 1990s. Prior to this time, many borrowers with
less than perfect credit profiles were generally not extended credit. The expansion of the
subprime market improved access to credit for these borrowers. As such, the subprime
mortgage market has likely played a large role in the increase of homeownership in the
country.1 According to the U.S. Census Bureau, the national homeownership rate
1 For more information regarding the subprime mortgage market, see CRS Report RL33930,
Subprime Mortgages: Primer on Current Lending and Foreclosure Issues, by Edward Vincent
Murphy.
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increased from 64.1% in 1993 to 68.9% in 2005.2 This increase was even more dramatic
for minority groups, who saw an increase of nearly 10% during that same time frame.3
This period of time also happened to coincide with a strong overall housing market, when
many homes increased in value.
The housing market began to slow down near the beginning of 2006. This downturn
has likely played a role in the rise of late mortgage payments and foreclosures occurring
across the country.4 Some in Congress are concerned that the problems with the housing
market will lead to increased filings for bankruptcy.5 As a result, a number of legislative
proposals have been introduced in the 110th Congress that are directed at the subprime
mortgage market, including at least four bills seeking to amend § 1322 of Chapter 13 of
the Bankruptcy Code (Chapter 13).6
This report provides an overview of the general Chapter 13 process and summarizes
how the four bills mentioned above seek to amend Chapter 13. As these bills, in some
cases, deal with matters beyond the scope of this report, the analysis of them is limited to
proposed effects on when the modification of mortgages secured by the debtor’s primary
residence would be allowed; when prepayment penalties on these loans would be waived;
whether and to what extent repayment of these loans would be allowed; whether and to
what degree interest rates on these loans could be modified; and whether and in what
circumstances the credit counseling requirement could be waived.
Overview of Chapter 13
Bankruptcy provides an avenue by which debtors may get relief from their debts.
There are two types of bankruptcies: liquidation and reorganization. Chapter 13 governs
reorganizations for individuals. This chapter also provides a framework for debtor-
creditor negotiations of repayment prior to a petition for bankruptcy by serving as a
baseline, which provides leverage for each side during these negotiations. Outside of
bankruptcy, debtors and creditors may consensually modify the terms of their contractual
obligations with the understanding that where they cannot agree, the terms are to be
modified in accordance with the parameters of the Code if the debtor files (and qualifies7)
2 Id. at 3-4.
3 Id. (homeownership rate of minorities increased from 42.4% in 1993 to 51.3% in 2005).
4 See CRS Report RL33930, supra note 1, and CRS Report RS22511, Preliminary Observations
on the Impact of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (P.L.
109-8), by Brian Cashnell, Mark Jickling, and Heather D. Negley.
5 See CRS Report RS22511, supra note 4 (while the overall bankruptcy rate for the year 2006 is
below the rate in 2005, it is likely that this reduction has more to do with a dramatic increase in
filings prior to the implementation of the Bankruptcy Abuse Prevention and Consumer Protection
Act of 2005 (P.L. 109-8), which was widely viewed as more onerous to debtors than the law in
place before the act, than a decreased need for bankruptcy protection during this period).
6 See S. 2133, S. 2136, H.R. 3609, and H.R. 3778.
7 For instance, 11 U.S.C. § 106(e) requires a Chapter 13 petitioner to have a regular income and
limited amount of secured and unsecured debt. Also in most cases, a debtor must receive credit
counseling prior to filing for bankruptcy under Chapter 13. For more information regarding the
(continued...)
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for bankruptcy. When a qualified debtor cannot negotiate revised payments with his or
her creditors, the debtor may file a petition for an individual reorganization. Under
Chapter 13, the debtor is required to file a reorganization plan with the court.8 Chapter 13
is a streamlined process, so the plan is generally submitted at the same time as the petition
for bankruptcy.9 Sec. 1322(a) states the requirements that all plans must meet. Sec.
1322(b) states additional parameters that a plan may meet, if applicable. If the plan meets
the Code’s requirements including the guidelines of § 1322, the court may confirm the
plan in accordance with § 1325.10
The Code provides the court some leeway to adjust the value of certain liens. For
many secured debts, the court has “cram down” authority, that is, the power to lower, over
the creditor’s objections, the debt’s value to as low as the collateral’s fair market value.11
Among the secured debts that the court does not have authority to modify under the
current Chapter 13 are those that are secured by the debtor’s principal residence.12 Section
§ 1322(b)(2) states in relevant part, “the plan may ... modify the rights of holders of
secured claims, other than a claim secured only by a security interest in real property that
is the debtor’s primary residence.” By virtue of this provision, a court may modify the
debt of a mortgage secured by a debtor’s vacation home, for instance, but may not cram
down the debt on a mortgage secured by the same debtor’s primary residence. The
purpose of the exception, at least based on analysis of its legislative history as expressed
in a concurring opinion by Justice Stevens, was to “encourage the flow of capital into the
home lending market.”13
7 (...continued)
Bankruptcy Code’s credit counseling requirements, see CRS Report RL33737, Credit Counseling
Requirements Under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 and
the Pension Protection Act of 2006, by Jennifer Staman.
8 11 U.S.C. § 1321.
9 Bankruptcy Rule 1007(c) allows the debtor to file a reorganization plan within 15 days of
petition.
10 11 U.S.C. § 1325 provides the standards by which a bankruptcy court may confirm a
reorganization plan.
11 11 U.S.C. § 1322(b)(2). To determine the fair market value of a collateral for the purpose of
exercising its cram down authority, the court generally holds a hearing during which the parties
submit evidence to support a value. After this hearing, the court determines the appropriate fair
market value, and that amount is used to set the reduced debt value, which is plugged into the
debtor’s reorganization plan.
12 Id.
13 Nobelman v. Am. Sav. Bank, 508 U.S. 324, 332 (1992) (citing Grubbs v. Houston First Am.
Sav. Ass’n., 730 F. 2d 236, 245-46 (5th Cir. 1984). Despite Justice Stevens’ statement, it is
unclear whether encouraging capital into the mortgage lending market was the only, or even
primary, legislative purpose of 11 U.S.C. § 1322(b)(2). The language of § 1322(b)(2) was the
result of a compromise between the House and Senate versions of the Bankruptcy Reform Act
of 1978 (P.L. 95-598). However, there was no conference report for this bill, and our research
of the legislative history of § 1322(b)(2) yielded no report language or recorded debate to explain
the purpose behind the exception for debts secured by the debtor’s primary residence. Grubbs’
conclusion, which was relied upon by Justice Stevens, appeared to be based on witness testimony
(continued...)
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Some legislators have questioned the equity of this exception. In the chairwoman’s
opening statement of the Subcommittee on Commercial and Administrative Law’s
markup of H.R. 3609 (discussed below), Representative Linda Sanchez stated: “The
current law is unfair and needs to be changed. That’s why I’m proud to be behind this bill
[H.R. 3609], which will restore fairness to hardworking American families struggling to
save their homes from foreclosure in bankruptcy.”14 Similarly, Representative Brad
Miller, another sponsor of H.R. 3609, argued that the disparate treatment of debts secured
by the debtor’s primary residence under the Code in relation to other secured debts is an
indication that the Bankruptcy Code favors businesses but not average homeowners.15
Bill Comparisons
S. 2133. S. 2133, the Home Owners’ Mortgage and Equity Savings Act, or
HOMES Act, would have the most limited effect on § 1322 of the four proposals. Section
2 of this bill would only allow judicial modification of a debt secured by the debtor’s
primary residence if the debtor meets specified income-level thresholds,16 and then only
if both the creditor and debtor agree to the adjustment in writing.17 Because of the written
13 (...continued)
during hearings on the act, which were conducted in the 94th and 95th Congresses. Some of the
more relevant testimony cited was given by Edward J. Kulik during the hearings from the 95th
Congress. Mr. Kulik, representing the Real Estate Division of the Massachusetts Mutual Life
Insurance Company, expressed concern about provisions of the bills that would allow
modification of secured debts. He stated, “[t]hese provisions may cause residential mortgage
lenders to be extraordinarily cautious in making loans in cases where the general financial
resources of the individual borrower are not particularly strong.” Mr. Kulik continued: “[s]erious
consideration should be given to modifying both bills so that, at the least ... a mortgage on real
property other than investment property may not be modified....” See Bankruptcy Reform Act
of 1978: Hearings on S. 2266 and H.R. 8200 Before the Subcomm. of Improvements in Judicial
Machinery of the Sen. Comm. on the Judiciary, 95th Cong., 1st Sess., 707, 714-15 (1977).
14 Linda Sanchez and Brad Miller Introduce Legislation to Relieve Homeowners From Sub-Prime
Mortgage Crisis, Press Release (September 27, 2007), [http://www.lindasanchez.house.gov/
news.cfm/article/348].
15 Miller speaks out on behalf of middle class homeowners in a House Committee on Financial
Services hearing on “Possible Responses to Rising Mortgage Foreclosures.” Press Release
(April 17, 2007), [http://www.house.gov/bradmiller/prpr20070417a.html] (stating: “Bankruptcy
laws have long been intended to help give people a fresh start ... [high net worth individuals and
businesses] can go into bankruptcy, they can shirk their obligations ... And, usually after they
come out of bankruptcy, the top executives all pat themselves on the back for their good work
by giving themselves a nice bonus. But, for the American homeowner, they can’t get a mortgage
obligation rewritten in bankruptcy ... American homeowners, the American middle class needs
someone on their side. American business has someone on their side. The American homeowners
need someone on their side. They need Congress on their side and I hope we will be.”).
16 This means test is based on the state’s median family income as well as the size of the debtor’s
family.
17 S. 2133, § 2 (It is unclear how long the holder of the claim would continue to hold the lien on
the property for the discharged portion of the debt under the bill.).
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agreement requirement, this provision of the bill does not seem as if it would
substantively change what is already allowed outside of bankruptcy.18
Currently, a debtor and creditor, if they so agree, could modify debt secured by the
debtor’s primary residence outside of bankruptcy. The provision from S. 2133 would
basically reach this same end, just in a slightly different way. Instead of the debtor and
creditor agreeing outside of bankruptcy to a repayment plan that includes a modification
of the debt secured by the debtor’s primary residence, S. 2133 would require a written
statement of agreement to modify, followed by the reorganization plan that include the
modification that would then be approved by the court. The only real difference between
the two is that S. 2133 would require a written agreement in bankruptcy that is otherwise
implicit to such an agreement outside of bankruptcy. What seems most important is that
a creditor’s agreement to modify a debt secured by the debtor’s primary residence is
presumably unlikely, especially in bankruptcy. Therefore, a proposal that does not provide
a court some authority to modify these debts in absence of creditor approval does not
substantively change what is currently allowed.
S. 2133 would also allow for a waiver of prepayment penalties and for certain
modifications of interest rates of some adjustable rate mortgages, but only if the debtor
meets the specified income-level thresholds provided in the bill.19 The bill would
additionally allow for a delay in the credit counseling requirement until after filing for
bankruptcy if a foreclosure has been initiated against the debtor’s primary residence.20 S.
2133 would not provide an extension of repayment beyond what is currently allowed
under the Code. Finally, the bill would sunset seven years after enactment.21
H.R. 3778. H.R. 3778, also named the Home Owners’ Mortgage and Equity Savings
Act or HOMES Act, is identical to S. 2133 with the lone exception that it would not
require written agreement by the parties before a court could cram down a debt secured
by the debtor’s primary residence.
S. 2136. S. 2136, the Helping Families Save Their Homes in Bankruptcy Act of
2007, would allow judicial modification of a debt secured by the debtor’s primary
18 This interpretation seems to be shared by the bill’s sponsor. Senator Specter, on October 5,
2007, stated on the Senate floor that S. 2133 “does not give bankruptcy judges the latitude to
reduce the principal on a mortgage.... My bill would only allow the reduction of principal if the
lender and the homeowner agree.” See Specter Speaks on Mortgage Crisis, Press Release
(October 5, 2007), [http://specter.senate.gov/public/index.cfm?FuseAction=NewsRoom.Arlen
SpecterSpeaks&ContentRecord_id=70319d9c-1321-0e36-bac8-2d8f6d5de585&Region_id=&
Issue_id=].
19 Id. (if the debtor meets the bill’s means test, a court may modify an adjustable rate mortgage
“by prohibiting or delaying adjustments to the rate of interest applicable to the debt on and after
the date of filing of the plan or voiding any such adjustments that occurred during the 2-year
period preceding that date of filing....”).
20 S. 2133, § 4. In most cases, a debtor must receive credit counseling prior to filing for
bankruptcy under Chapter 13. For more information regarding the Bankruptcy Code’s credit
counseling requirements, see CRS Report RL33737, Credit Counseling Requirements Under the
Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 and the Pension Protection
Act of 2006, by Jennifer Staman.
21 S. 2133, § 6.
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residence but only if the debtor meets an income means test.22 More specifically, a cram
down would be allowed if
after deduction from the debtor’s monthly income of the expenses permitted for
debtors described in section 1325(b)(3) (other than amounts contractually due to
creditors holding such allowed secured claims and additional payments necessary to
maintain possession of the residence), the debtor has insufficient remaining income
to retain possession of the residence by curing a default and maintaining payments
while the case is pending....23
If the debtor meets the means test, S. 2136 would allow payment to extend for thirty
years less the number of years that the mortgage has been outstanding.24 The bill would
also allow adjustment of the interest rate for repayment at a fixed annual percentage rate
equal to “the most recently published annual yield for conventional mortgages” by the
Federal Reserve’s Board of Governors “plus a reasonable premium for risk,” if the debtor
meets the means test.25 In addition, the bill would allow the court to waive any
prepayment penalty provided in a mortgage secured by the debtor’s primary residence,
without regard to the means test.26 Finally, the bill would eliminate the credit counseling
requirement if a foreclosure sale has been scheduled, without regard to the chapter of the
Bankruptcy Code under which the debtor has filed.27
H.R. 3609. The Emergency Home Ownership and Mortgage Equity Protection Act
would provide the most significant changes to the Code of the bills analyzed in this report.
By not providing a means test that must be met prior to cram down, H.R. 3609 entirely
eliminates the exception from judicial modification of debts secured by the debtor’s
primary residence. As a result, courts would have cram down authority over these debts
in all cases validly filed under Chapter 13. By granting the court such broad authority to
modify these loans, the bill would seem to allow courts to adjust interest rates and
prepayment penalties. The bill would allow for payment of claims secured by the debtor’s
primary residence beyond the five years allowed under the current Code, without
specifying a new time limitation.28 Additionally, H.R. 3609 would eliminate the credit
counseling requirement for debtors who have filed a Chapter 13 petition that includes a
claim secured by the debtor’s primary residence if a foreclosure has been initiated on that
residence.29
22 This means test is different from the one in S. 2133 and H.R. 3778. It is unclear how the bill
would affect the creditor’s lien on the portion discharged.
23 S. 2136, § 101.
24 Id.
25 Id.
26 S. 2136, § 201.
27 S. 2136, § 102.
28 H.R. 3609, § 6 (The holder of the claim would continue to hold a lien on the property for the
discharged portion of the debt until the reorganized debt is paid. By not specifying a new time
limitation, the bills apparently would allow a bankruptcy court to extend payment beyond even
30 years.).
29 H.R. 3609, § 5.