Negotiating a mortgage modification is an alternative to New York bankruptcy that frequently pops up, even though the Home Affordable Mortgage Program was not so successful. Nevertheless, modifications are perfectly reasonable. Debtor-homeowners can reduce their interest rates and monthly payments to align their mortgage costs with their incomes, particularly when they’ve lost substantial equity in the housing market. However, modifications for underwater, junior mortgages can wind up costing debtors if chapter 13 offered a better alternative. Here’s why.
Chapter 13 allows debtors to strip liens on underwater, junior mortgages. For example, let’s say a debtor borrows $150,000 to buy a home. Then the home’s value rises by $30,000. The homeowner borrows another $30,000 against that equity. Then a bust hits, and the formerly $180,000 house is now worth $130,000. At this point, depending on how much of the loans the homeowner has paid, the original mortgage is greater than the home’s value, but the home equity loan is now secured by zero equity. Debtors can file in chapter 13 and strip away the home equity loan completely. This is one strategy for keeping an underwater house and reducing mortgage payments.
In the mortgage modification scenario, the lender might offer to reduce the outstanding principal on the original mortgage. Accepting this offer will reduce monthly payments and total payments to the lender, so it appears to be a good deal for staying in the home. However, if the principal reduction diminishes the first mortgage to, say, $110,000, then the home equity loan is suddenly above water to the tune of $20,000. This mortgage cannot be stripped in chapter 13, and now the debtor must repay it. If the homeowner were to sell the home, the original lender would be fully repaid and the home equity loan’s bank would take $20,000, leaving the homeowner with a $10,000 debt.
The question for the homeowner is whether the opportunity to strip the lien is more valuable than the total amount he or she would pay with a loan modification. Astute readers will notice that I’ve generously frontloaded this hypothetical to favor the modification, $140,000 total mortgage debt with the modification versus $150,000 with the stripped junior mortgage. Again, the biggest factors to weigh are the amount that’s been paid off—which is excluded here for simplicity—and how much of a principal reduction the lender is willing to accept. Debtors’ circumstances greatly influence the outcomes, but in truth, stripping the lien is almost always the better option as the junior mortgage becomes an unsecured debt that receives only a small portion of its total value from the chapter 13 plan.
Filing bankruptcy in the Southern District of New York and parts of the Eastern District of New York also allows debtors to participate in the loss mitigation program, which forces lenders to negotiate possible modifications. While the process is ongoing, lenders cannot file for relief from the automatic stay. The program has resulted in modifications of more than half of debtors’ loans. By filing bankruptcy debtors get the best of both options.
If your home is underwater and there’s a second loan on it, then you should talk to an experienced New York bankruptcy lawyer to fully explore your options.
For answers to more questions about bankruptcy, the automatic stay, effective strategies for dealing with foreclosure, and protecting your assets in bankruptcy please feel free to contact experienced Brooklyn bankruptcy attorney Bruce Weiner for a free initial consultation.
