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Shift in Strategy on Mortgage Modifications – Try to Stay One Step Ahead

In a prior post, I suggested that if a homeowner had a first and second mortgage on their home, and the balance on the first mortgage exceeded the present market value of their property, it may have been prudent to complete a mortgage modification on the first mortgage before venturing into Chapter 13 bankruptcy to cramdown or “strip” the under secured second mortgage lien.  An interesting issue and twist was raised today in an article in the New York Times in which there was a brief discussion about the scenario (which is now proving to be extremely common) in which the same “party in interest” holds both the first and second mortgages.   I am using the term “party in interest” because in the Wild West of  mortgage ownership and servicing, the name of the institution that holds the instrument is now meaningless – it is the ultimate decision maker that counts – be it the bank, servicer or investor (good luck trying to work your way through that mess).

As the report continues, parties in interest are turning down applications for modifications on first mortgages if they also hold the second on the basis that, upon information and belief, they do not want to adversely impact their joint position as second lien holder.    If more and more mortgage modifications are being denied on this basis – it is time to shift gears and attack the second mortgage first in Chapter 13 bankruptcy.

There is one temporary downside to this strategy that your must understand fully before venturing into bankruptcy, namely that in a Chapter 13 bankruptcy in which you are not repaying your creditors in full, you are required to devote all of your net disposable income to your Chapter 13 plan. While the initial payment to the trustee under your plan is determined by the means test and your current income and expense, your payment could increase substantially during the life of your plan if you modify your first mortgage after the second mortgage is stripped while in a Chapter 13 plan. For example, let’s say that your present first mortgage payment is $2500.00 per month and your plan payment is $300.00 per month. Six months into your case, you are successful in modifying your first mortgage, and you have reduced your first mortgage payment from $2500.00 to $2000.00 per month. The euphoria of this reduction will quickly wear off as the trustee will most likely demand that your plan payment increase by a comparable amount since you now technically have “additional disposable income”. In this case, you could now be looking at a plan payment of $800.00 per month instead of $300.00 per month.  Although it may still prove to be less costly in the long run (since you no longer have either a second mortgage payment or credit card payments), there may be a short term cost to obtain that long term gain.

The above discussion is only an example – not a general statement.   The dynamics of each case is unique.  Any proposed strategy regarding lien stripping and the renegotiation/modification of mortgages in Chapter 13 bankruptcy should be reviewed on a case by case basis with an experienced bankruptcy attorney.