The real estate bubble is one the primary culprits behind the rise in individual bankruptcy filings. Many debtors therefore are looking for ways to reduce their monthly payments, if not get out of their home obligation entirely.
In an effort to avoid filing bankruptcy, nearly every home owner with a troubled mortgage has attempted a loan modification to some degree. Although most attempts usually fail, even on the rare occasions when the modification has been approved, the debtor often still feels the need to file bankruptcy. As such, it is important to consider the impact and ramifications of a home mortgage loan modification before, during and after bankruptcy.
Loan modifications before a Chapter 7 bankruptcy are not binding as to the note unless reaffirmed in the bankruptcy. If the loan is not reaffirmed in the bankruptcy, the note is then discharged. The debtor and lender can still honor the agreement as to the lender lien rights (under a stay and pay scenario) without a reaffirmation agreement, but the note obligation would be forever discharged. Therefore, a debtor who saw his/her monthly mortgage payments slashed in half with a modification before bankruptcy might still not want to reaffirm the mortgage in the bankruptcy if the principal balance was not reduced and the home still has negative equity.
Loan modifications during a Chapter 7 bankruptcy are binding if they are approved by the bankruptcy judge through a signed reaffirmation agreement. The debtor can still reaffirm a note which is not the exact same deal as the pre-petition obligation. A modification is essentially a reaffirmation agreement under better terms. Any modification agreed to during the case without bankruptcy court approval is not binding as to the debtor obligation on the note and is discharged.
Loan modifications after a Chapter 7 bankruptcy can only be binding as to the debtor on the note if the debtor reaffirmed the mortgage with court approval during the pendency of the bankruptcy case. 11 USC 524 prevents the debtor and creditors from entering into an agreement after bankruptcy for a debt that was discharged in bankruptcy. Therefore, unless the mortgage was reaffirmed in bankruptcy, any post discharge home modification is only binding as to the creditor lien rights.
Loan modifications before, during and after a Chapter 13 bankruptcy are binding as to the debtor obligation under the note because the debtor who retains a home in the Chapter 13 does not discharge the note. The debtor Chapter 13 repayment plan is determined in part by the amount of money available to the debtor after the debtor pays the home mortgage, so a modified mortgage can lead to an increased payment to the debtor unsecured creditors.
It is important to note that most modifications start with a three-month trial period where the lender can back out for almost any reason before offering a permanent modification. One popular reason lenders deny permanent modifications is because of changed circumstances. As such, debtors should be wary of filing bankruptcy during the 90-day temporary modification trial period and just assuming the lender will continue to honor the modification agreement.