Bankrupt, Underwater and Want to Refinance

Dear Bankruptcy Adviser, We filed a Chapter 13 bankruptcy in February because we were about to lose our home in a trustee sale scheduled for Valentine's Day. Now we need to figure out what our next moves should be. Would it be preferable to continue the Chapter 13 bankruptcy? Or should we try to refinance our home mortgage with the bank? We are upside down on the home, in a big way. Its value is around $90,000 and the mortgage is roughly $200,000. But I don't want to sell or lose this home.

-- Arnold

Dear Arnold, You do not clearly understand the options available to you. Or perhaps I should say the options not available to you. You ask whether it would be preferable to stay in the bankruptcy or try to refinance the mortgage. However, refinancing the mortgage is not an option. If any reader has ever been able to refinance his or her mortgage when the mortgage is upside down, please email me. I would be very interested to know which banks are being so generous. The lender has no incentive -- and all the risk -- when refinancing a loan where no equity exists.

Besides equity in your home, lenders like to see that you are a stable and viable borrower before refinancing. However, you filed a bankruptcy right before the trustee sale of your home. A trustee sale is the result of foreclosure, which means you were not making your mortgage payments. Regardless of the reason you weren't paying, it would be a stretch to prove you're a stable loan candidate since you filed bankruptcy after not paying the mortgage for quite some time.

At this point, I believe you only have two available options to save the home. Let's discuss each of these possibilities in depth.

The first option is to stay in the Chapter 13 bankruptcy. This is known as a reorganization bankruptcy. It requires you to bring the loan (or loans) current over the next three to five years. During that time, you will make mortgage payments plus a payment to the person assigned to your case, called a trustee, for your other bills. (In some locations, you will make your mortgage payment to the bankruptcy trustee as well.) The lender will not be able to reject your loan payments when you file this type of bankruptcy. You will keep the house so long as you make the mortgage payments and any payment to the trustee.

Another idea: Apply for a loan modification. A loan modification is a process where the terms of a mortgage are changed from the original agreement. However, I am assuming you already tried to modify your loan, and were rejected. That usually is what causes the homeowner to file Chapter 13 bankruptcy to save the home.

Many lenders still will consider a loan modification even while the borrower is inside an active Chapter 13 bankruptcy. Most commonly, lenders want to see 12 months of consistent mortgage payments while you are in Chapter 13. That shows the lender you may be more stable now than before.

Again, I would be very interested to learn if you can successfully refinance your home. That would be the best outcome, but I believe it's an impossible scenario. You need to get reorganized and bring the mortgage current. This can be achieved in the Chapter 13 bankruptcy.