A compromise version of a bill that would allow bankruptcy judges to modify the terms of troubled debtors’ mortgage loans — including reducing the principal to reflect a home’s actual value — has emerged from the House Judiciary Committee, where opponents had hoped to scuttle it.

H.R. 3609, the Emergency Home Ownership and Mortgage Equity Protection Act of 2007, squeaked by Wednesday on a 17-15 vote.

Critics, including the Mortgage Bankers Association, say that if the bill becomes law, it will increase the cost of all mortgages, because it would undermine confidence in the ability of lenders to collect payments. Interest rates on mortgages might go up 2 percent, some critics have said.

Those who support the bill, such as the Center for Responsible Lending, say bankruptcy courts are already allowed to rewrite the terms of automobile loans and credit card debt, and that giving them such power over mortgages would provide lenders an incentive to modify loan terms before they end up in foreclosure.

The bill that emerged from the House Judiciary Committee represents a compromise with Ohio Republican Rep. Steve Chabot, which would limit bankruptcy judges’ “cramdown” powers to existing nontraditional and subprime mortgages originated after Jan. 1, 2000. If the bill becomes law, it would not apply to mortgage loans made after that date.

In addition to reducing a loan’s principal, judges would have the power to reduce interest rates and prepayment penalties, and set aside other fees for debtors who file for chapter 13 bankruptcy relief and who lack sufficient income to remain current on their mortgages and cure arrears.

MBA Chairman-elect David Kittle said that the compromise bill would still have the potential to increase the rates on most mortgages by 1.5 percent to 2 percent.

“Giving judges the power to completely rewrite a loan contract between a lender and a borrower brings into question the value of the collateral the loan is made against, which is the cornerstone of our mortgage finance system,” Kittle told MBA NewsLink. “The end result will be a major repricing of risk by lenders.”

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