Published November 06, 2012
Dear Bankruptcy Adviser,
My client recently filed bankruptcy and has since been offered a loan modification from his lender. As I understand, the mortgage company does not have a legal right to pursue the client for the debt. But my question is: What happens if the borrower ever needs to transition out of the home if it is sold or transferred? If he accepts the modification, is he still responsible for the debt owed, and does the total amount become due at the sale or transfer date? Can he still claim the interest on the mortgage on his income taxes?
You ask a lot of good questions, Tiffany. Many homeowners face this decision post-bankruptcy: Keep the home or walk away. While I can't give an answer that absolutely covers all 50 states, this would apply to a majority of cases.
You are correct that the lender cannot sue your client for any unpaid balance in the event your client does walk away from the house. If your client stops making mortgage payments, the lender can only foreclose on the property after the bankruptcy case is over. However, the bankruptcy does not constitute a default allowing the lender to take the house when the homeowner is current on the payments.
Your client is also afforded all the same benefits of homeownership. He or she can write off the interest and property taxes and can access equity in the property. He or she can also sell or transfer the house to family, friends or a third party.
You can also work on a loan modification with your client. It appears to me that lenders are approving more loan modifications now than ever before. Let's hope that is the case for your client.
A loan modification does not re-establish liability on the loan. While the terms of the loan might change, the loan is not being refinanced. Refinancing the property into a completely new loan would re-establish liability, but not a loan modification. This is an important distinction.
Recently, some clients are telling me that lenders will not work on a loan modification unless the homeowner reaffirmed the loan during the bankruptcy. A reaffirmation agreement is a legally enforceable contract filed with the bankruptcy court that states your promise to repay all or a portion of a debt that may otherwise have been subject to discharge in your bankruptcy case.
Depending on what state your clients live in, this could be a very risky decision. Your client could reaffirm a loan that was otherwise discharged in bankruptcy, thereby re-establishing that eliminated liability. If your client lives in a state in which the lender can pursue a homeowner post-foreclosure for a deficiency balance, reaffirming the loan could be a horrible decision.
I think that will be the key to helping your client: whether reaffirming the loan will result in liability that was otherwise wiped out in bankruptcy. Once you confirm that information, your client can make an informed decision.
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