Tuesday, January 13, 2009

Bankruptcy and Loan Modifications: Hype or Help?

You may have heard commercials from attorneys and loan modification gurus offering loan modification services through bankruptcy. They are probably referring to proposed legislation called the Helping Families Save Their Homes in Bankruptcy Act. Beware of the hype, because this has not become law and may change significantly before it becomes law, assuming it becomes law at all.

How Current Bankruptcy Laws Impact Mortgages

Under current bankruptcy laws, debtors who qualify can file a Chapter 13 repayment plan bankruptcy proposing to strip unsecured liens, other than a first mortgage, from their home. Lien stripping is available if a second mortgage is completely unsecured (i.e. the fair market value of the home is less than the balance on the first mortgage). The following example may illustrate the point better:

Example: In 2000, husband and wife purchase a home for $500,000 with 100% financing, including a $400,000 balance on their first mortgage (30-year fixed rate at 6%) and $100,000 on a second mortgage (adjustable rate mortgage). in 2008, the home value has dropped to $350,000 and the formerly happy homeowners now have $50,000 in credit card debt because their mortgage payments are now beyond their ability to pay. In a Chapter 13 bankruptcy, the debtors have the capability of completely removing the second mortgage and treating it as unsecured. However, current bankruptcy laws do not allow any type of modification to the first mortgage.

What Will The Proposed Legislation Do?

A common frustration that I hear from potential clients is that they cannot get their lender to modify their mortgages to a more reasonable payment or interest rate. With falling home values and spiraling mortgage payments, adjustable rate mortgages are a common cause of home foreclosures. The Helping Families Save Their Homes in Bankruptcy Act makes the following proposals:

  • Eliminating a provision of the bankruptcy law that prohibits modifications of first mortgages;
  • Changing the Chapter 13 debt limitations to allow more debtors to qualify for a Chapter 13 repayment and lien stripping plan;
  • Permitting bankruptcy judges to modify variable interest rates with a new interest rate that will keep the mortgage affordable while allowing creditors to get a fair return on their investment;
  • Make filing bankruptcy easier by waiving the pre-bankruptcy credit counseling requirement for families facing imminent foreclosure; and
  • Requiring lenders to give proper notice when assessing fees and allowing judges to waive prepayment penalties.
When Will These Proposals Become Law?

It is too early to tell if the proposals will even become law, let alone what the final law may look like. Supporters and lobbyists are lining up on both sides to have their say and there are 2 different versions pending, one before the Senate and one before House of Representatives. For now, the best advice is to ignore the hype and remain watchful. In the meant time, contact a qualified bankruptcy attorney if you are facing foreclosure or need other debt relief assistance.

About the Author: Carl H. Starrett II has been a licensed attorney since 1993 and is a member in good standing with the California State Bar and the San Diego County Bar Association. Mr. Starrett practices in the areas of bankruptcy, business litigation, construction, corporate planning and debt collection.


Anonymous said...

Great article!
I will set myself up on your feed and look forward to hearing more about this.

Unknown said...

Thanks for your article. It clarified some questions for me. However, what will your example look like with the new bill? Will the home owner move the $50K in first mortgage to unsecured? Or will the $50K be just forgiven? If it is moved to unsecured, then other creditors will be hurted badly by this new bill, especially if it is a lot more than $50K, right? If you respond, will you please copy it to my email also? My email is wenmin.x.qin@chase.com. Thanks a lot,

Carl Starrett said...

Even as I write this, there are revisions and proposals being made. It is really hard to predict what the final bill would look like. Under the the current law, a partially secured claim is split up. Upon completion of the plan payments, the unsecured portion is discharged just like any other unsecured debt.

Unknown said...

It is estimated that it could benefit 3 to 4 million homeowners from the new modification procedures. So how do you qualify for the Mortgage Modification? Check the website http://mortgagemodificationprogram.blogspot.com
to see if you qualify. I was in trouble I am glad I did check it before I talk to my mortgage company and it worked - John Mayer, California

Loan Mo said...

Good informative article....thanks for sharing this info blog.

Frustrated and concerned said...

I am totally beside myself. My wife and I had declared bankruptcy last year at this time, while at the same time trying to modify our mortgage. No one ever told us we could not modify while in bankruptcy, not our attorney nor the bank. In March my bankruptcy attorney advised me to have our case dismissed so we may work on our loan mod. Still no one made us aware that we could not modify if we were in bankruptcy. I made head way with the bank and they agreed to a loan mod. We received the stipulation agreement with our 6 month trial period. Our last payment was due in September. Due to the IRS and other creditors we had to re file in June as advised by our attorney. So yes we had to pay the refilling fee again and now our loan modification was denied yet again, without anyone advising us that this would happen. I have been working with our bank to modify through the bankruptcy department since September only to find out yesterday that all loan mods are on hold until the treasury department figures out what the new procedure is to be. We have run out of money to pay our mortgage which is an arm. Please let me know if there is anything at all we may do to get our loan mod back on track. Our bankruptcy attorney is no help and I am wondering if I should find another. Thanks for listening to my rant.

Anonymous said...

I too am trying to modify my home loan which is only a first. I am in CH 13 Bankruptcy. I was told today by someone that I talked to that they do not allow for a modification if you are in bankruptcy. Is that true. My attorney nor did Bank of America tell me that this cannot be done. I am actually suppose to get a reply from BOA by the middle of the month. What can I do?