Loan Modifications and Bankruptcy
Loan modifications and bankruptcy is a confusing topic to some debtors. Loan modifications in a chapter 13 are much simpler than in Chapter 7.
In Chapter 13, the debtors loan in a mortgage is part of the bankruptcy. The debtor can modify it as part of the chapter 13 bankruptcy. That loan is not being discharged in the chapter 13 bankruptcy if the debtor modifies during her chapter 13 bankruptcy. It will it require court approval, but the court almost certainly will approve the modification because the debtor is lowering their monthly payment on their mortgage.
Modifying a mortgage in a chapter 7 context is much more complicated. The first thing to consider is whether the modification is entered into before the debtor files bankruptcy. When the debtor files bankruptcy, the debtor has the opportunity to discharge their mortgage. They will do that if they do not reaffirm their mortgage. Therefore, the debtor could enter into a modification before they file bankruptcy, and then immediately discharge the mortgage.
Now the debtor might not want to discharge the mortgage even though they just modified their mortgage. They might want to not reaffirm the mortgage they just modified, because often loan modifications do not lower the principal balance and only reduce the monthly payment. Thus, the debtor might have negative equity in their home, even though their monthly payment is a manageable.
Therefore, the debtor will probably want to reaffirm the modified mortgage. The debtor will then just continue to pay the monthly payment of the modified mortgage and the bank will continue to accept payments. Almost certainly in exchange, the debtor will not have to worry about a foreclosure because the debtors making the monthly payment.
Now let’s say the debtor tries to modify their mortgage in the middle of their Chapter 7 bankruptcy. If the debtor modifies in the middle of their Chapter 7 bankruptcy, the loan might be discharged in the bankruptcy. That depends if the loan modification is officially called a reaffirmation agreement that goes through court approval, or if it’s just an informal agreement between the debtor and the bank, that does not require court approval.
If it does not get approved by the judge, it has been discharged in bankruptcy. If it does get approved by the judge during the case, then it is not discharged and the modifiable loan has been “reaffirmed” by the debtor in bankruptcy.
The final scenario is where the Chapter 7 debtor modifies a mortgage after they filed bankruptcy and after they were discharged. If the debtor had reaffirmed the mortgage in bankruptcy prior to modifying after discharge, then that modification does take affect and is binding. That is not because of the modification was entered into after bankruptcy, but was because the debtor reaffirmed it while in bankruptcy.
On the other hand, which is probably going to be the majority scenario, there is the debtor that did not reaffirm their mortgage in bankruptcy but then enters into a modification after bankruptcy. That modification does not reaffirm the debt.
The debt was forever discharged in the bankruptcy under code section is 11 USC 524. The lender cannot get the debtor to once again take any personal liability on the mortgage by entering in a modification after bankruptcy when it was already discharged.
What the bank is modifying is the bank’s lien rights to foreclose. There is no personal liability being modified and being forced upon the debtor since the debtor discharged the mortgage in bankruptcy when they did not reaffirm it. That is true whether the debtor modifies the loan after bankruptcy or not