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Is the Mortgage Modification Process Simply a Prelude to a Chapter 7 or Chapter 13 Bankruptcy Filing?

In one of my recent posts, I listed a series of myths that you may encounter regarding the mortgage loan modification process. Upon further reflection, I may have discovered a major flaw in the entire mortgage modification process.

On September 13, 2009, Newsday reported that the number of Long Island homeowners that had mortgages that were at least 90 days past due had risen significantly from July to August while the number of homes “repossessed” (a verb used in this instance to categorize a foreclosure that has been completed by a lender – meaning that a foreclosure sale has taken place) had decreased during the same period.

At first blush, the net effect of this report could be perceived as positive news (if you are a lender) in that, since the number of completed foreclosure sales has decreased in the face of increasing delinquencies, the mortgage modification process must be beginning to work. This may not necessarily be the case. In fact, it may be a precursor to a new wave of Chapter 7 and/or Chapter 13 Bankruptcy filings in the near future.

Over the past few months, countless clients have intimated to me that, although they were current in the remittance of their mortgage payments, they made inquiries to their lenders about the mortgage modification process. In many of these situations, the lender’s representatives advised the clients that they (the lender) would not entertain an application from a customer for a mortgage modification unless, or until, they “were at least 90 days in arrears.” Think long and hard about this statement – LENDERS MAY BE ADVISING HOMEOWNERS TO DAMAGE THEIR CREDIT AND FORCE THEM INTO BANKRUPTCY. The following is what could be a very real hypothetical situation.

Our hypothetical couple are homeowners living on Long Island, and they have a mortgage at 6.5% percent. They are current on their mortgage payments. In addition, they have $50,000.00 in credit card debt against which they are also current on their payments. They are interested in applying for a mortgage modification to lower their mortgage payments.

On day one, they contact their lender and are told that they must be 90 days in arrears before the lender will entertain an application for a mortgage modification. The representative from the bank, thinking that they are assisting our homeowners, suggests that our couple stop paying their mortgage “for a couple of months” and set aside those funds in preparation for a mortgage modification. Our couple, not fully thinking through all of the ramifications, follows the suggestion of the lender’s representative and stops paying their mortgage.

On day 90, they contact their lender again and begin the process. They dutifully fill out their application for a mortgage modification and provide all of the documents requested by their lender. A week or two goes by. They contact their lender for a status report on their application. They are now dealing with a representative in the loss mitigation department. The representative advises our couple that although the lender has received the application, it will not be assigned to a modification processor for another 30 days because of backlogs. The representative advises our couple to call back in 20-30 days.

On day 120, our couple calls their lender and is advised that their application has been assigned to a representative at extension xxxx. Our couple is transferred to this extension, and their call is forwarded to voicemail, wherein our couple leaves a message. This sequence of events occurs once a week for the next 30 days.

On day 135, our couple’s boiler fails and needs to be replaced at a cost of $5,000.00. This emergency depletes over half of the cash reserves that they were holding for their mortgage modification.

On day 150, our couple receives a letter from their lender stating that since they applied for their modification 60 days ago, the pay statements and bank statements provided with the application are now “stale” and must be updated. Our couple immediately overnights the documents to the lender. Another two weeks passes…

On day 165, our couple receive a notice from their credit card holder (coincidentally, with the same lender) stating that since their mortgage was now 150 days in arrears, their credit score had dropped by some 100+ points. As a consequence of this decrease, the line of credit on the credit card with the lender was being capped and the interest rate was being increased from 9% to 27.99% . On day 180, our couple receives two other notices from other lenders with essentially the same information.

On day 190, our couple finally receives the word that they have been awaiting for the past 90 days. They have been approved for a “Conditional Mortgage Modification.” Since they are now six months behind, the lender is willing to modify our couple’s interest rate to 5.5% for 60 months, at which time it will go back up to 6.5%. The lender is also requiring that our couple go through a trial period in which they will be required to remit mortgage payments $300.00 higher than their regular payments for 3-4 months. If our couple remits these payments in a timely fashion, the modification will go into effect. The new payment on the modified mortgage will be only $200-300.00 lower than their original payment because of the mortgage arrears and the advances that the lender made for real estate taxes and insurance.

The net effect of our saga, now almost seven months later is as follows:

1. Our couple’s credit rating is now down countless points.
2. They are six to seven months behind on their mortgage, and appear to be at the mercy of their lender.
3. The monthly payment on their mortgage will be increasing by $300.00 per month for 3-4 months at which time the payment will only decrease by $200-300.00 per month from their original payment.
4. The minimum payments on their credit cards have increased by $750.00 per month as a result of the drop in their credit score and interest rate changes.
5. Our couple calculates that the mortgage modification will cost them $500-600.00 more per month than when they started.

They are in a quandary. Family members suggest that they seek advise before they go any further. Unfortunately, a bankruptcy filing may now be their only option to deal with all of their debt issues at one time.


Special Note and Disclaimer: This is only a hypothetical. The fact pattern presented above is not specific to any single situation, but this combination of events, in the approximate sequence described above, could actually occur. Something to think about…..