Mrs. Free’s Studios Davenport Iowa

Can I Modify my Home Mortgage in Chapter 13 Bankruptcy?

Yes – you can modify your home mortgage in a Chapter 13 Bankruptcy by Stripping Off The Second Mortgage and other junior liens.

Today, you can modify your home mortgage in two ways:  Get a modification from the lender or file a Chapter 13 bankruptcy and attempt to strip off the second mortgage on your home.  Oftentimes, this will reduce the balance on your mortgage by 30%.  While this isn’t perfect, it is oftentimes, the difference between being able to keep your home or being forced to surrender it in foreclosure.

So how does this work.? First it is important to determine whether you should file bankruptcy.  Second you need to file a Chapter 13 bankruptcy.  Third, your bankruptcy attorney files an adversary procedure with the court to rule that the value of your home is less than the balance on  your first mortgage.  Fourth get the Chapter 13 plan confirmed by the court whereby the second (third, fourth, fifth and any junior mortgages) are wholly unsecured and will be paid as unsecured creditors.  At the end of the plan (60 months), the second mortgage and all other junior mortgages are released by the lender and the debtor/s is left with a home with only one mortgage.

Does this work in real life applications?  In the last year over 40% of our firms Chapter 13’s had successful plan confirmations with the second mortgage being stripped.    On average this reduced the principal by 30% on the home indebtedness.

So what is not so great?  The first mortgage still has to be paid off in full with all of the arrearages paid back over 60 months along with the costs of collection plus the first mortgage may still have a balance that is more than the home can be sold for…so why has the court allowed this to occur – the answer is in the intent of the bankruptcy code, the idea was that if home mortgages could be modified in bankruptcy, why would anybody pay their mortgage?  Therefore, to save the ability for consumer to get home mortgages from banks, the bankruptcy code strictly prohibits the modification of a home mortgage this is wholly or even partially secured even if secured by only $1.

Bottom line – Chapter 13 offers a crude type of home mortgage modification by getting rid of unsecured mortgages, however, it does not fix long term problems with a first mortgage.  If your first mortgage is OK by itself then this type of modification is for you.  If your first mortgage is still a problem, then it may be wise to simply surrender the home in the bankruptcy and let the lender take the loss.

What are we seeing now is unbelieveable – it never used to happen in the past, but it is happening now: After filing the bankruptcy  and after stripping the second mortgage, the lender on the first mortgage voluntarily modifies the first mortgage to make the plan easier.

So what is this all about?

Well…here’s the best way to describe it.  Typically, the interest rate is reduced to 2% for the first five years and it increases by 1/2% per year after that until it hits the market rate and then becomes fixed at that rate.  The kicker is that the bank will put the arrears on to the balance of the loan.  Doesn’t seem like a big deal, but it is!  If your old mortgage payment was $2400 per month and you were 10 months behind at the time of your bankruptcy filing, then you owe $24,000 in arrears.  In a typical 60 month chapter 13 plan, you will pay $24,000/60 per month to pay back these arrears.  This is $400 per month.  In this case, the bank basically put this into the balance.  So basically, you are now paying 2% interest on $24,000 over the next 30 years or so.  Around $50 per month.  The benefit is theoretically that your home if you keep it for 15 years will finally be worth more than the mortgage; you can sell it, pay off the mortgage and have a happy life.  This is all true with one caveat.  What if you have to get out of the house one year after your bankruptcy ends and you are still “underwater”   Good luck – you just entered another bankruptcy or years of garnishments.

In a nutshell – if you want to live in your house a long time and don’t have a big need to move soon and don’t believe you will be forced to move, then this is the ticket.  Basically, the bank cuts its price on loaning you the money.  But if you need to be more flexible and actually have the debt load be less immediately, then you are out of luck and better surrendering the home in bankruptcy.

Examples:

Ron and Karla bought a home in 2006 for $200,000.  The first mortgage was $160,000 from Wells Fargo.  The Second Mortgage for $40,000 was from Banco Popular.  Ron and Karla were doing great until Karla lost her job in 2008.  The couple missed 8 payments.  The couple was five months into their foreclosure action when they filed a Chapter 13 Bankruptcy.

Ron and Karla hired David Nelson to file their Chapter 13.  David suggested that they keep their home, but attempt to strip off the second mortgage.  Ron and Karla agreed.

Ron and Karla make approximately $70,000 per year together and have two children.  Their budget is tight and the means test says that they need to contribute on 10% of their plan to paying unsecured creditors.

Ron and Karla have no other debts besides the home.  Their mortgage payment was $1400 on the first mortgage, $500 on the second and their tax escrow was $300 per month.

Ron and Karla were $11,200 in arrears on their first mortgage when they filed their bankruptcy.

Here is how their plan payment is figured.

$1400 for payment of the first mortgage regular payment
$300 for tax escrow payment on the first mortgage
$67  (10% of $40,000 divided by 60 months) for payment of the unsecured second mortgage
$187  ($11,200 divided by 60 months)
$1954 Subtotal
$195  Trustee Fee (10% of payment)
$2149 total payment

So how does this work out with their budget

$70,000 Gross Income Per Year
$5833 Per Month Gross
($1458)  Taxes
$4375 Net Income Per Month

$2149 Plan Payment
$250  Gas & Electric
$800  Food
$194  Clothing
$100  Laundry
$250  Medical
$502  Transportation
$130  Auto Insurance
$4375  Subtotal

Square Budget.  Home Saved.  Overall home mortgage modified by overall reduction by 20%

Bottom line – this Chapter 13 accomplishes good things.  With other applications we might have an auto loan, additional credit card debt or other unsecured debt.  For those discussions, please see my other blog postings.

For more information about bankruptcy, mortgage modification or other debt relief options, please call NLO Nelson Law Office at 877-464-6656 or email us at info@nelsonlawoffice.com