Oct 11, 2008

Hold Off on Chapter 7 Bankruptcy If You Might Qualify for a Mortgage Modification

On October 6, it was announced that Countrywide Financial has agreed to the largest program ever to modify (reduce) the principal and interest of home loans as part of a lawsuit settlement with officials in 11 states. This was followed several days later by the passage of the federal bailout bill, which contains language likely to also result in widespread loan modifications. In other words, if you have defaulted on your mortgage, or are likely to default in the near future, help may be on the way.

This raises an interesting question for homeowners who are contemplating filing bankruptcy: What effect will bankruptcy have on a homeowner's ability to participate in a lender's home loan modification program? While only time will tell for sure, here are two important points to consider.

First, when you file a Chapter 7 bankruptcy (the most common kind), the title to your home technically passes to your bankruptcy estate and is "owned" by the bankruptcy trustee -- the official appointed to handle your case. Countrywide is telling its homeowners that it won't consider them eligible for a modification while a Chapter 7 bankruptcy case is pending. So filing bankruptcy might take you out of the action just at the wrong time.

Even more problematic, a Chapter 7 bankruptcy typically cancels the promissory note portion of your mortgage along with your other debt. However, even if you don't owe anything on the mortgage itself, the lender will still have a lien on the property in the amount of the mortgage, and will be entitled to foreclose on that lien. In other words, even though you don't owe anything on the mortgage after bankruptcy, you'll still have to pay on it if you want to keep your house. Confusing? You betcha.

So, what's my point? If you don't owe anything on your house after your mortgage, you won't have a mortgage to modify, and it's unlikely that the new programs will offer modifications for liens remaining after bankruptcy. The only way to avoid this result is to offer to reaffirm the mortgage as part of your bankruptcy case (that is, agree to a new mortgage) and hope the lender agrees. As part of this process you can attempt to negotiate different terms for the new mortgage that would be similar to what you would otherwise get outside of the bankruptcy process.

Bankruptcy used to be a really good remedy for people facing foreclosure. However, in the brave new world of mass mortgage modifications, bankruptcy may foreclose your ability to partake of the manna from heaven pouring forth from our nation's mortgage lenders. For this reason, if you think you might qualify to have your mortgage modified, either by Countrywide or by your lender, strongly consider holding off on your Chapter 7 bankruptcy until you know which way the mortgage modification winds are blowing. For more information on whether you might qualify to have your mortgage modified, find a non-profit HUD-certified housing counselor by calling 1 888 995-HOPE.