Loan Modifications and Bankruptcy

Lately, I've been seeing a lot of homeowners who are considering bankruptcy but are also in the process of trying to get a loan modification with their lender because they have a foreclosure pending. A lot of them are telling me that their lender has told them that they are not qualified for a voluntary loan modification because of their high debt-income ratio.

What this means is that if you owe a lot in other debts (such as credit cards, personal loans, etc.) besides your mortgage, the bank may think that even though your mortgage payments are lower after your loan is modified, it would still be difficult or impossible for you to keep your home because you have other debt obligations that must be paid (and a lot of people in foreclosure are also behind on all their other debts so these debts are showing up as collection accounts on their credit report).

In other words, the bank may be telling you that given your current debt load, you simply cannot afford to keep your home, and they would rather cut their losses and foreclose on your home because they are left with no other option. Bear in mind that banks hate foreclosing on any property but will do so as a last resort.

The reasons behind this are simple. First, banks have been under a high degree of scrutiny after thousands of foreclosures filed within the last two years were found to be illegal. Federal regulators found that many banks had improper record keeping practices, and that executives had routinely signed foreclosure affidavits even though they had no personal (or specific) knowledge that the loans they were attesting to were delinquent. Since then, the federal government has been keeping a close eye on mortgage modifications, since a number of foreclosures took place shortly the homeowner had agreed to make trial payments while the modification was pending.

Second, lenders have no interest in being property brokers. Once a property is foreclosed upon, the property is sold at a substantial loss. The bank has the added expense of finding (and approving) another buyer, which could take several more months after the redemption period has expire. While the property sits on the market, the bank is not collecting any money. Instead, they would rather earn a return on their investment (the loan you are paying), and paying your mortgage helps them do so, even if it is at a reduced rate.

Because of the massive number of foreclosures that the banks are currently dealing with, I find Filing bankruptcy, Chapter 7 or Chapter 13, will immediately stop the sale from going forward, and the bank will need court permission to continue with the process if mortgage payments are not being made. An experienced and knowledgeable bankruptcy attorney can explain to you how Chapter 7 or Chapter 13 may help you save your property or at least postpone the foreclosure sale so that you can look at all other possible options. In Chapter 13, it is also possible to "strip down" or remove your 2nd mortgage if the current market value is below the amount of the 1st mortgage.

Eliminating (or at least consolidating) your debts may improve your debt-income ratio and this may be what your lender wants to see when considering your application for a loan modification. Of course, this is just one of the factors that they take into account when evaluating your financial information. Just as important are your ability to show regular and stable employment as well as an assurance to the lender that whatever caused the financial hardship to begin with is now behind you so that you can afford your new mortgage payment once your loan is modified.