Should I Take Loan Modification While in Chapter 13?

Dear Bankruptcy Adviser,

We are in our last year of Chapter 13 bankruptcy, which should strip off the second loan of our underwater home. However, we recently heard from our lender concerning our conventional loan. They are offering us a loan modification with a 2% interest rate for seven years, after which it would not exceed 4%. We are nervous about what to do. Also, how will this affect our bankruptcy case and cost if we are approved? Thanks in advance.

-Dee

Dear Dee,

We have finally seen the total evolution of the mortgage crisis. From 2008 through 2011, lenders were rejecting most or all loan modifications. Clients had to file Chapter 13 bankruptcy to try and save their home and repay delinquent mortgage payments. The majority could not afford the bankruptcy and regular mortgage payment, so many not only lost their home, but also stained their credit with a bankruptcy notation.

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Now, mortgage lenders appear to be easing loan modification requirements. While I do not have any specific numbers, I can just see the difference on a client-to-client basis. I am not filing as many Chapter 13 bankruptcies as I was three or four years ago, and the ones I am filing seem to end early because the lender approves a loan modification.

You filed Chapter 13 bankruptcy, which is a repayment of some or all of your debt over a three- to five-year period. The court assigns a trustee to oversee your case, receive a monthly plan payment and handle distribution to creditors.

This is also the only type of bankruptcy available where you can eliminate a second mortgage. To completely eliminate it, you must complete your Chapter 13 plan and receive a discharge. There may be an exception in your particular bankruptcy district, but the vast majority of cases still require that you receive a discharge to eliminate the second mortgage.

Right now, you should definitely take this opportunity to modify your first mortgage and lock in a very low interest rate. I assume the modification will also lower your monthly payment. Since you will not be inside the Chapter 13 bankruptcy for the rest of your life, this modification will help your monthly cash flow once you complete your case.

By agreeing to the loan modification, you will also need to satisfy the lender's conditions. Most lenders require that you get court approval for the loan modification. You likely will have to file a motion and get a judicial order approving the modification agreement. Even though some judges in locations where I practice say this is an unnecessary requirement, many lenders are afraid to do anything that would violate the protections bankruptcy affords you. So this may be a cumbersome but necessary step.

You then may need to modify your Chapter 13 plan payment. Most loan modifications do lower your monthly payment, which will leave additional money in your budget. You will not be able to benefit from that extra money while the Chapter 13 case is still active. The trustee assigned to your Chapter 13 case will want you to use that additional money to pay more to the other creditors, including the second mortgage being eliminated. This is an important step not to ignore as your first mortgage payment may come down significantly after the loan modification.

Even if the Chapter 13 plan payment does go up, you don't want to pass on the long-term benefits of the loan modification. Locking in an affordable payment now will only make life easier for you once the bankruptcy ends.

Good luck!

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