A loan modification is a second mortgage
There was a time a few years ago when I couldn't have written about mortgage modifications in a bankruptcy proceeding. That's because the banks were in a mess and the change programs were a joke. Customers were constantly being told that there was a lack of paperwork. You would fax and email documents over and over again. Every time they contacted the bank, they were referred to a different customer service representative who no one could find any accounts or files or documents from.
Customers gave up after numerous attempts.
Today I'm happy to say that the banks seem to have turned a corner. While there are still disagreements, the banks and mortgage companies seem, by and large, to be doing a pretty credible job of getting their clients through the process without too much stress.
Many of our customers come to us on the verge of bankruptcy. Sometimes they are unaware of their options to modify their loans. Sometimes they are too late before they want to change something. Sometimes banks go ahead with foreclosure even though their customers are trying to sell the property, get refinanced, or have begun the change process. We're filing a bankruptcy case to take advantage of auto stay, an injunction to stop those foreclosures and other collection actions, giving debtors (that's what we call bankruptcy filing folks) a little respite, and either much or the rest of their debts through a Chapter 7 case, or you on a Chapter 13 amortization schedule that will address not only your mortgage arrears but other obligations as well.
The nationwide change program is called the Home Affordable Mortgage Program, or HAMP. In this article, we'll look at what HAMP can do and how it works in a bankruptcy case.
What is the difference between a refinance and a loan modification?
If you need new terms or a way to make your home more affordable, you have two options: refinance or change.
Refinancing replaces the old loan with a completely new one. Refinancing is usually designed to reduce the interest rate or to change less favorable conditions, such as a variable rate, to more favorable conditions. It can be done by the current lender or a brand new lender. It requires that the borrower is creditworthy and that the property has not decreased in value so that the loan is underwater (the borrower owes more than the property is worth.
A change changes the terms of the current loan. It doesn't require the same credit rating that a refinance has, although the borrower must show that he has enough income to make the payments. In fact, the loan modification program is designed to help homeowners who have suffered some kind of financial reversal have to help. It can be permanent or it can be temporary if there is any reason to suspect that the borrower's circumstances will change. There is often more flexibility in what a lender can be willing to do to make the loan affordable, but the interest rate will often be higher than the borrower could get into a refinance.
Can you still get a mortgage modification in the event of bankruptcy?
Yes. In fact, many of my clients have successfully modified their loans and emerged from bankruptcy with less debt and an intact and current mortgage.
Who can qualify for a Mortgage Modification?
It depends on your servicer and whether your loan is held by a bank, a mortgage company, or a company like Fannie Mae or Freddie Mac. Everyone has their own requirements and criteria. But in general, you will likely qualify, though
- You spend more than 31% of your monthly income on housing costs (mortgage payments, insurance, property taxes, homeowners association contributions).
- You are not otherwise eligible for a mortgage refinance.
- You are either delinquent or in arrears because of a change in financial circumstances.
- The home has decreased in value and you owe more than the home is worth.
HAMP changes can be used to change loans for primary residences and certain rental properties.
What does the change in mortgage mean?
First is the application. Most lenders require proof of income to ensure that the borrower has at least a minimum income to be able to make modified payments. Most lenders also require a credit report, although there is no minimum or maximum credit score necessary. This is usually to determine how much other debt the borrower has to service each month.
Second is the testing phase. Once all the papers are complete and the lender determines that the borrower is likely to meet their minimum requirements, the borrower will be offered the opportunity to make a series of test payments. Three payments are the number I see the most often.
Once the trial payments have been successfully completed, the lender makes a final decision about the change and offers the change to the borrower.
What loan terms will change?
The goal of a HAMP change is to make the loan affordable to the borrower and to prevent the lender from losing more than they have to. The lender can change virtually any payment term, including
- Lower the interest rate
- Convert the loan from an adjustable rate to a fixed rate
- Extend the interest rate, for example from 30 to 40 years
- Add arrears to the back end of the loan
- Retained some of the most important
- Award some of the most important
What about changes and bankruptcies?
When someone files for bankruptcy, the bankruptcy court takes over jurisdiction over almost everything that involves the manager's finances; the debtor (which is what we call the person filing a bankruptcy) is allowed to do day-to-day transactions like buying groceries and keep paying utility bills, things we call "ordinary business".
A loan modification is not “the normal course of business.” Whether the bankruptcy court needs to take action to approve the modification depends in large part on whether the case is Chapter 7 or Chapter 13. In a Chapter 7 case, which usually lasts four to six months, some lenders will approve the debtor. In a Chapter 13, the debtor must always seek judicial approval, regardless of whether the lender requests it or not. To obtain this court approval, the debtor's lawyer must file an application with the court.
In a Chapter 13 case, the debtor proposes a plan to settle their debts by making a payment to a trustee who distributes the funds received to creditors who have filed claims. The plan must include certain types of debt such as overdue income taxes or domestic support obligations such as child support and alimony. It can include arrears to the mortgage company and secured debts such as cars and appliances.
Since in almost every case the mortgage arrears are included in the change, the debtor's attorney must also apply for a change to the Chapter 13 payment schedule in order to clear the arrears. Depending on what else the debtor wanted to achieve with the Chapter 13 plan - pay off senior debts like recent income taxes or child support, or make a car payment more affordable by adding them to a Chapter 13 plan. may decide that a Chapter 13 case is no longer necessary or helpful. At this point she can consider whether it would be advisable to convert the case to a Chapter 7 case or to reject it entirely.
How it works in bankruptcy proceedings
Here's an example: Let's say the debtor filed a Chapter 13 case and included $ 5,000 in overdue mortgage payments. After filing Chapter 13, the debtor applies for a loan modification with his mortgage company. While in Chapter 13, he continues to make payments to Chapter 13, which includes the $ 5,000 owed to the mortgage company.
For example, suppose a year after the case was submitted, the mortgage modification is approved. By then, the lender has paid $ 1,000 through payments to the Chapter 13 trustee. The loan modification includes the $ 4,000 that remain owed on the repayment claim.
The debtor no longer wants "extra" money to the mortgage company, so their attorney must do two things. First, the attorney will file a petition with the bankruptcy court asking the court to approve the mortgage loan modification. Sometimes the motion needs to be determined for a hearing before the judge. Sometimes it can be stored for a set period of time - often 24 days - to allow an interested party to oppose it. If neither party objects and the terms are favorable to the debtor, it is most likely that the bankruptcy judge will approve; if one party objects, the change will be scheduled for a hearing so that all parties can testify and argue with the judge.
Once he has an injunction from the court approving the change and the debtor actually enters into the change agreement, his attorney will ask the court to change the terms of the plan to remove the arrears to the mortgage company. This will also bring movement. The process is similar to applying for the loan modification. The request has been made for the hearing, or it remains in the files for a certain period of time in order to give creditors the opportunity to examine it and, if necessary, to object.
Or the debtor can forego the plan change process and submit an application for conversion to Chapter 7 or an application to reject the case altogether, depending on what the debtor might otherwise be lurking in his financial picture.
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