Chapter 7 Bankruptcy Time Bomb: Mortgage Modifications

by Eugene Melchionne, Esq.

April 22, 2012

House Explosion

Last time, we talked about how a mortgage modification could screw up your ability to avoid a second mortgage in a Chapter 13 bankruptcy.  If your principal balance is lowered on your first mortgage, your second mortgage may survive a Chapter 13.  But there are other dangers for Chapter 7 in the mortgage modification settlement.

Maybe your bank won’t reduce your principal balance.  That can be a good thing.  But, consider this: if your bank reduces your mortgage monthly payment, that may free up other portions of your income forcing you into a Chapter 13 bankruptcy case rather than just discharging your debts in Chapter 7.

Understand the differences between Chapter 7 and Chapter 13.  Chapter 7 discharges your debt immediately giving you a fresh start right away and Chatper 13 requires a budget payment plan to your creditors over a three to five year period before you can get your fresh start.

Part of fling for bankruptcy requires that you pass the means test.  It requires that your income be below the average or if above average, with no disposable income left over at the end of the month.  That disposable number is based on what the government says you can afford, not necessarily how you are spending your money.  As a result, a reduction in your mortgage payment can result in failing the means test.  If you are above average income and have disposable income, you have to enter a five year payment plan under Chapter 13.

So if your mortgage company reduces your mortgage payment as little as two or three hundred dollars a month under the mortgage settlement, that disposable income will be dedicated to your other creditors and will not benefit your monthly budget at all.  Every month, you will pay the Chatper 13 Trsutee that savings who will distribute it to your credit cards and other delinquent debt.

The best way to avoid the potential problem is to review your finances with a bankruptcy attorney before you finalize that deal to modify your mortgage loan.  Don;t let this “settlement” lure you into the false sense that it will cure your financial ills.

“ConnecticutGene Melchionne is a bankruptcy lawyer covering the entire State of Connecticut. He can often be found on Google+ and Twitter, where he shares information about consumer protection issues and personal finance.

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Last modified: November 17, 2013