If you're in serious financial trouble, you may be considering bankruptcy; and if you have a mortgage, you're probably also trying for a loan modification. But will filing for bankruptcy protection prevent you from getting your mortgage modification? It depends.
You may have even given up hope of solving your financial troubles, but fear not: Understanding the guidelines and pitfalls of applying for a mortgage modification and filing for bankruptcy will help to ensure your greatest chance for successfully re-casting your obligations.
The official word on bankruptcy and loan mods
HAMP administration guidelines state that you can get a mortgage modification if you file for bankruptcy protection. "A borrower actively involved in a bankruptcy proceeding is eligible at the servicer's discretion; however, any modification under HAMP entered into while the borrower is in bankruptcy proceedings must be approved by the bankruptcy court before the borrower is allowed to exit the trial modification period and become permanent."
Check with your lender before filing
Many servicers have loan retention or loss mitigation guidelines on their websites. Check those first to see if there is anything about active bankruptcy filings and modifications. If not, try emailing them to see if you can get an answer in writing. Otherwise, call and ask to see if you can get the employee to fax you written guidelines that state the servicer's policy about modifications in bankruptcy.
Bankruptcy filing may affect your NPV test...
Bankruptcy may also affect the least-understood part of the loan modification process -- the Net Present Value or NPV test. This is a calculation designed to determine if the lender is better off modifying your mortgage or not. Part of this test involves quantifying the likelihood of you defaulting on your mortgage in the future if you were to get a modification. Some lenders consider bankruptcy a positive, reasoning that if your other debt payments are reduced or eliminated, you have a better shot at paying your mortgage. Others may not: Bankruptcy does torpedo your credit score, and credit score is a factor in NPV testing.
"Loan Mod Guru" Anna Cuevas, author of Dirty Little Loan Modification Secrets You Must Know, and provider of free mortgage modification advice says, "In my experience I have not seen a negative effect from [bankruptcy] on NPV. I have gotten a permanent HAMP mod for many people who had bankruptcies. I believe the main reason for NPV failing is not being able to get the payment to 31% by way of the rate reduction and term extension -- especially if the value is not underwater or if the lender is not doing principal deferment or the amount is too great."
Chapter 7 bankruptcy, mortgage reaffirmation and loan modification
If you're heading for bankruptcy, you'll need to decide what to do with your mortgage loan. "Reaffirmation" is an agreement filed with the bankruptcy court between you and your lender in which you re-establish the loan that existed before filing for Chapter 7 bankruptcy, the discharge of your debts (it isn't applicable if you file Chapter 13, a reorganization of your debts). That debt would otherwise be discharged in your bankruptcy (and you would surrender your property). In a Chapter 7 situation, you'd waive your right to eliminate that particular debt and you'd get to keep your property. Understand, however, that the court does not require you to reaffirm your mortgage, and just by continuing to make your mortgage payments as agreed, you get to keep your home. In addition, there are some really good reasons to not reaffirm your mortgage with the court.
- Reaffirming your mortgage may make you ineligible for a HAMP mortgage modification after bankruptcy. According to HAMP, "Borrowers who have previously received a Chapter 7 bankruptcy discharge in a case involving the first lien mortgage, who did not reaffirm the mortgage debt under applicable law, are also eligible."
- Reaffirming your mortgage may leave you vulnerable to deficiency judgments if you end up losing your home. Bankruptcy protection allows you to avoid deficiency judgments in the event that you lose your home to foreclosure, deed-in-lieu or short sale. If you live in a state that allows deficiency judgments, this is a major consideration and you should consult a bankruptcy attorney before signing anything.
Many lenders and mortgage servicers tell homeowners that their mortgage documents require them to reaffirm if they file for Chapter 7 bankruptcy. This may not be true; you and your attorney should refer to your loan documents to make sure. Some mortgage servicers will not consider a homeowner's request for mortgage modification (including HAMP) unless the homeowner reaffirms.
Some bankruptcy attorneys recommend that you not reaffirm the debt without a firm, written modification offer specifying all terms, including the interest rate. Otherwise you could end up buying "a pig in a poke" -- taking on personal liability and getting no modification in return.
Some servicers may refuse to process your loan mod request without a reaffirmation, creating a catch-22 for you. You don't want to reaffirm your mortgage without a modification offer, but the servicer doesn't want to process your request without all the required paperwork in hand, including a reaffirmation. In that case, your bankruptcy attorney may be able to break the logjam.
It may not even come up: Many servicers have been so inundated with new business that they've had to hire less-experienced employees, and their processes are often quite disorganized. They may not even raise the issue of reaffirmation for a post-bankruptcy modification. So of course you won't want to "remind" them about the bankruptcy discharge.
What if you've already reaffirmed your mortgage debt?
You can cancel the reaffirmation agreement within 60 days after it is filed at the bankruptcy court. It should be canceled prior to the discharge order being issued. You need to inform the mortgage lender about your decision to cancel the agreement.
The bottom line
It's a good idea to try for your loan modification before filing for bankruptcy protection; you can always file once you're in the trial period if your need is urgent. In the meantime, find out all you can about your lender's policies regarding bankruptcy filings. If you find yourself denied for a loan mod and in foreclosure, a timely bankruptcy filing can buy you some time with what's called an "automatic stay," can discharge late fees and capitalize your arrearages; and it may even make it possible for you to keep your home. Try to avoid reaffirming your mortgage, especially if you live in a state that allows deficiency judgments. Lastly, get professional help. Bankruptcy attorneys offer free consultations; hire the one who answers your modification questions easily and has a proven track record of working well with mortgage lenders.
Gina Pogol has been writing about mortgage and finance since 1994. In addition to a decade in mortgage lending, she has worked as a business credit systems consultant for Experian and as an accountant for Deloitte.