I recently explained why a mortgage modification might be an inferior choice to a chapter 13 bankruptcy. As it turns out, mortgage modifications can stymie a chapter 7 New York bankruptcy as well. Why? Two reasons: the means test and exemptions.
I’ve discussed the chapter 7 means test in detail before, but debtors whose household incomes exceed the median family income for their state must demonstrate why their cases aren’t abusive filings. Essentially, it requires showing why a chapter 13 case wouldn’t be feasible. Because mortgage modifications (even without principal reductions) reduce debtors’ monthly payments, the resulting savings could raise debtors’ disposable monthly incomes to the point that they fail the means test.
Here’s an example, using the current bankruptcy dollar amounts:
Say a debtor earns $127 in disposable monthly income and pays a monthly mortgage payment of $2,500. Debtors taking the means test in Kings County, which includes Brooklyn, as of April 2016 can deduct $1,761 in mortgage or rent payments from their “current monthly incomes” on their way to calculating their “disposable monthly incomes.” If the debtor obtains a mortgage modification that reduces the monthly mortgage payment to $2,450, then the debtor ends up with an extra $50 per month in “disposable monthly income.”
The debtor adds the $50 to the preexisting $127 and multiplies it by 60, giving us $10,620, which is well above the $7,700 income limit for staying in chapter 7. If the debtor doesn’t owe much in nonpriority unsecured claims, he or she might need to file in chapter 13. If the mortgage modification loosened anything more than $87 in income, then the debtor would fail the means test absent special circumstances.
Notice in this example that unlike the post about mortgage modifications and chapter 13, there is no junior mortgage to worry about. A mortgage modification affecting a senior mortgage alone can throw a debtor out of chapter 7.
Alternatively, but less likely, a debtor might obtain a mortgage modification that includes a principal balance reduction. This is often a good deal, but reduced principal means the possibility of increased equity (or at least less negative equity), and equity in a house is an asset that debtors must cover with an exemption to keep the property. For most New York homeowners struggling to pay their mortgages, a principal reduction is probably not going to lift them over the exemption limits because the state’s exemptions are so strong. Our Brooklyn homeowner can exempt up to $165,550 in equity, so it’s doubtful such a debtor will get a substantial enough principal reduction to go over that limit. However, a principal reduction is more likely to force a homeowner out of the federal exemptions, which has a homestead exemption of only $23,675.
Mortgage modifications can give debtors relief from high monthly payments, but if debtors have other debts, then the modification might do more harm than good, and chapter 7 New York bankruptcy might offer a better result.
For answers to more questions about mortgage modifications, 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.