The number of homeowners who were placed in foreclosure naturally increased by 81% between 2007 and 2008. Congress is now set to pass legislation that will make it possible for homeowners to reduce their mortgage debt in bankruptcy.

However, lenders resist cramming down the principal owed on a property owner’s mortgage. Lenders would much rather assist distressed homeowners by lowering interest rates, extending the term of their loan and leaving the principal untrimmed. However, this brand of assistance is generally feckless at best, as has been demonstrated in the FDIC IndyMac case. Most homeowners with modified loan terms that do not include a debt cramdown end up defaulting again within six months.

first tuesday take: But here is the catch-22 for homeowners which will damn this legislation. If the value of the property owner’s home later appreciates as the real estate market improves, the increased value would be shared with the lender under a swap of the excess debt for a share in the owner’s future equity. The proposed cramdown arrangement would leave the homeowner in a long-term position of sharing their equity with the lender on any future sale of the home, also called an appreciation participation arrangement or swap. It would be financially more advantageous for the owner to let the property go back to the lender in foreclosure and get a “fresh start” owning a new home without sharing any of its future appreciation with the lender.

Re: Mortgage ‘cramdowns’ could be on the way,” from