A Fresh Start with a Mortgage Modification

Mortgage modification may reduce your monthly payments but not likely reduce your balance owed. So it costs less short-term, not long-term.

Quick Definition

A mortgage modification is a permanent restructuring of one or more of the terms of the mortgage intended to make it more affordable on a monthly basis.

Compared to Forbearance Agreement

A mortgage modification is intended to deal with the permanent unaffordability of the mortgage payment, while a forbearance agreement deals with a short-term unaffordability.

With a forbearance agreement the monthly mortgage payments don’t change. The lender simply gives you a limited time to catch up on missed mortgage payments, while you must make your full regular mortgage payment as well. If you simply don’t have the cash flow to do that—even after writing off most or all of your other debts in a Chapter 7 “straight bankruptcy”—than you should look closely at mortgage modification.

Compared to Chapter 13

In a Chapter 13 payment plan you are specifically NOT allowed to modify the terms of a first mortgage, but are given much more time than in a forbearance agreement to catch up any missed payments. In this respect it’s better than a forbearance agreement, but perhaps not as good as a mortgage modification that reduces the monthly payment amount.

However, if there’s a second mortgage, and if the home is worth no more than the balance of the first mortgage, Chapter 13 may be able to altogether do away with the second mortgage’s monthly payment. And you may only need to pay a small part of that second mortgage debt, or even none of it, before the remaining balance is discharged (written off). That could potentially save you tens of thousands of dollars. If so, Chapter 13 could be much better on both a monthly and long-term basis.

Furthermore, there are many other possible benefits to Chapter 13 if there are other liens on the home (such as for unpaid property taxes, income taxes, or judgments). And Chapter 13 can greatly help with other special debts even if they are not liens on the home, such as income taxes, support obligations, other marital debts, and student loans. Taken all together these may make Chapter 13 the best way to go.

Caution

Keep the following in mind:

• The qualification standards for a mortgage modification can very rigid. Whether done through a governmental program or with the lender directly, the new modified monthly payment is usually defined as a targeted percentage of your monthly gross income, usually a particular percentage between 31 and 41 percent. That new payment must be enough to pay off the loan within some extended period of time, say 40 years. Or sometimes some of the principal is deferred until the house is sold or refinanced. But if the numbers don’t pencil out, the modification is not approved.

• Going through a mortgage modification can be arduous. Generally, to be eligible for a loan modification, you must:
  • provide a great deal of required documentation to the lender for evaluation, including:
    • a financial statement
    • proof of income
    • most recent tax returns
    • bank statements
    • a hardship letter
    • show that you cannot make your current mortgage payment due to a financial hardship
    • complete a trial period to demonstrate you can afford the new monthly amount

• Don’t expect a write-down of the mortgage debt. Mortgage lenders have fought tooth and nail to resist “principal reduction.” Why not forgive some of the debt to make the debt more affordable? First, as simplistic as this sounds, lenders want to avoid opening the door to reducing their balances. They simply hate to voluntarily let go of money legally owed to them. Second, lenders may believe that they are contractually bound to those who invested in the mortgage-backed securities to not write down the debts.  

Conclusion

Mortgage modification is not easy to pull off because you must fit within a narrow window of having enough income but not too much. And even if you and your home do qualify, jumping through all the hoops takes great persistence and attention to detail. Furthermore, a successful modification on the short term can still mean paying more for your home in the long run.

So find out as quickly as possible if you can realistically qualify, and be assertive in providing the required paperwork and following through. Most importantly, get advice about the various ways that Chapter 13 could help and potentially be better than a modification. Or you may find out that a mortgage modification may only work when done TOGETHER with a Chapter 13 case to reduce your other debts.