Bankruptcy and Legal Implications of Loan Modification

All of the recent talk about loan modification has raised as many questions as it has answered. Can you get a better loan modification deal through bankruptcy? Will a loan modification damage your credit? Do you have a legal right to a loan modification? What information will you need in order to get a loan modification?

You may have read that Congress was going to give bankruptcy judges the power to modify mortgages. A few bills were floated during the early part of 2009, but none became law. As the law currently stands, a bankruptcy judge cannot modify your loan. In some cases, a bankruptcy attorney may be able to negotiate a modification for you, and in some cases you can get rid of a second mortgage in a Chapter 13 bankruptcy, but you won’t be able to force the lender to change the terms of your loan. In fact, in some cases, bankruptcy can invalidate a loan modification agreement that you already have in place. If you have a loan modification agreement, and then file for bankruptcy, in many cases the modification agreement will be voided and you will have to renegotiate with your lender. If you file bankruptcy with a lawyer, you will either need to have your lawyer handle the negotiation or have your lawyer give the servicer permission to discuss the matter with you.

While in some cases, a loan modification may affect your credit, experts say it’s rarely the most important consideration. For one thing, the alternatives (foreclosure, bankruptcy, or mortgage default) are probably worse for your credit. For another, it depends on what sort of modification is made and how it is reported. For example, if the modification reduces the amount that you owe, the transaction could get reported as a debt settlement, which would have a negative impact on your credit. But getting back to the main point, even if a loan modification does hurt your credit score, it probably won’t hurt the score as much as a foreclosure, bankruptcy, or a series of late or missing payments.

Finally, you do not have a right to a modification. While the federal government encourages mortgage modification and has offered some subsidies for those who agree to them, loan modifications aren’t mandatory. Servicers consider several factors in reviewing a request for loan modification. For one thing, this is one time when having a lot of equity in your home can hurt. If the loan value is much lower than the value of the property, it makes foreclosure less expensive to the servicer. They are more likely to try to liquidate the debt by foreclosing and selling the property. Another factor is risk. Your servicer is taking a risk by modifying your loan; it is agreeing to take lower payments and hoping you will make them. Moreover, it costs them more money in administrative costs to service modified loans.

Therefore, they want you to prove that you can make the payments. You should be prepared to offer details about your income and expenses and explain how you will be able to make the payments. Most servicers also want a “hardship letter.” This is because they don’t want to help those who were able to make their current payments, but decided to try to get them reduced. You’ll need to explain what changed circumstances prevent you from making your current payments.

When you contact your servicer to request a modification, you should have the following information handy, according to financialstability.gov:

  • Information about monthly gross income, including recent pay stubs, and documentation of any income received from other sources.
  • Most recent income tax return.
  • Information about your assets.
  • Information about any subordinate lien mortgage on the house.
  • Account balances and minimum monthly payments due on all credit cards.
  • Account balances and monthly payments on all other debts such as student loans and car loans.
  • A “hardship letter,” which describes why your mortgage is unaffordable.