Learn the options for modifying a mortgage in bankruptcy.
In most cases, only the mortgage company (lender) can modify the terms of your mortgage agreement. In limited circumstances, however, the bankruptcy court can adjust your mortgage in a Chapter 13 bankruptcy case. That doesn't mean that filing for bankruptcy won't be helpful. A bankruptcy filing might help you qualify for a loan modification, or at least give you time to pursue that option.
Chapter 13 Mortgage Modification
In a Chapter 13 bankruptcy, you propose a plan to pay something back to your creditors over three to five years. There are two ways that you can modify a mortgage in a Chapter 13 bankruptcy. The processes available are lien stripping or cramdown.
Lien Stripping
Lien stripping allows you to remove a second (or later) mortgage when you owe more than the value of the property securing the mortgage. The catch is that if you were to sell the home, there would have to be no money available to pay the stripped mortgage.
For instance, suppose that your house is worth $100,000.00 and you have a first mortgage of $105,000.00, and a second mortgage of $15,000.00. If the house were sold, all available funds would be used to pay the first, leaving nothing for the second mortgage. You could strip the second mortgage because the balance of the first mortgage leaves no equity to secure the second mortgage.
Over the course of your repayment plan, you'd pay on the second along with your other unsecured debt (like credit card balances, medical bills, and personal loans). Because this payment is based on your income, it's unlikely that you'd pay more than what you would have had you not stripped the lien. The lien goes away after you complete your repayment plan.
Cramdown
A cramdown means that you pay only the value of the property through the plan. The remainder of the balance gets paid with other unsecured creditors. In other words, you keep the property while paying what it's worth only. Anything that you owe over and above the property's value gets wiped out with your other unsecured debt.
The problem is that most people cannot meet the requirements necessary to take advantage of a cramdown. It's available for real estate in a Chapter 13 bankruptcy only if the loan was secured by more than just your residence (such as if you put up your car or stocks as collateral, too) or you used the loan in one of the following ways:
- to purchase an investment property that you don't live in
- to purchase your residence and other property that is not part of your residence (such as farmland or an apartment building)
- to purchase a mobile home that is personal property and not real property.
The drawback to a cramdown is that you must pay off the entire reduced loan amount during the plan, which isn't possible for most people.
Loan Modification in Bankruptcy
If your loan isn't eligible for lien stripping or a cramdown, you still might be able to modify your loan while in bankruptcy.
- Chapter 13 bankruptcy. If your mortgage payments are behind, you will propose a plan that catches up the payments while making regular, on-going payments. You can also ask the mortgage company to modify the terms to lower the payments, or catch up the payments that are behind. The bankruptcy court must approve any loan modification, and once approved, will likely change the terms of your plan. It is important to have an experienced attorney to help you through the process.
- Chapter 7 bankruptcy. There is no process available in a Chapter 7 case to modify the terms of a mortgage through the bankruptcy court. Also, the lien stripping and cramdown processes aren't allowed in a Chapter 7 case. If you want to keep otherwise exempt property (meaning that you can protect all of your equity) in a Chapter 7 bankruptcy, you need to make arrangements to continue paying the mortgage by reaffirming the debt (agreeing to continue to pay per the original agreement). In rare cases, you might be able to redeem the property by paying the value of the property in a lump sum, but this isn't an option for your primary residence. You can ask the lender for a loan modification, but you should be aware that granting it is entirely up to the lender.
Modifying a mortgage in any manner in bankruptcy is complicated. Making an error can be costly—especially if it means you lose your equity. It's highly recommended that you seek bankruptcy counsel.
