Negotiating Mortgage Modification Can Create Substantial Abuse Issues in Chapter 7 Bankruptcy

Dealing with your mortgage company and filing Chapter 7 bankruptcy are supposed to be independent of one another. Filing Chapter 7 bankruptcy should not effect your relationship with the mortgage lender of an exempt homestead property; but, it can in some cases. Debtors above applicable median income must past a means test to file Chapter 7. The general rule is that your monthly mortgage payments are a deduction from income for means test purposes and help you qualify for Chapter 7. The means test formula implicitly assumes that people should pay their home mortgage first and if after paying the mortgage, and other secured debts, they do not have enough money left to pay unsecured creditors they are more likely to pass the means test. However, if people have not paid their mortgage for several months they could have a problem filing Chapter 7 bankruptcy. Although they remain liable for the debt and can use the debt for means test purposes, the United States Trustees office often challenges these Chapter 7 filings on the basis of "substantial abuse." The U.S. Trustee argues that having not paid their mortgage payments these Chapter 7 debtors have remaining enough cash flow to repay a significant portion of unsecured debt in Chapter 13, and therefore, their Chapter 7 filing should be denied and converted to a bankruptcy under Chapter 13. Of course, substantial abuse is determined on a case by case basis. Many debtors who cannot afford mortgage payments cannot afford to repay credit cards as well, whereas some people may be hoarding cash if they decide to stop paying their mortgage to relinquish an upside down house to their mortgage lenders.

The issue becomes more complicated because of mortgage lenders’ prevailing policy of not negotiating mortgage modification with homeowners with up to date mortgages. The majority of lenders will start modification discussion only after the homeowner is at least three months behind, and greater delinquency increases the homeowners negotiating leverage. Many people in financial difficulty may want to discharge unsecured debts and negotiate a mortgage modification. When they purposefully stop paying mortgage payments to qualify for modification they may be creating a substantial abuse issue with the U.S. Trustee if they try to file Chapter 7 against unsecured debts. It’s a classic rock and hard place dilemma for may people in today’s economic environment resulting from the conflict of mortgage lender’s policies and U.S. Trustee policies. I am not aware of any court decision which considered this situation , but I current have a few clients trying to file Chapter 7 bankruptcy with this fact situation and legal issue.

posted by Jonathan Alper, bankruptcy and asset protection attorney, Orlando, Florida

Comments

[JC]

With all of the new laws and push by the Feds to stop foreclosures has anything changed in the Chapter 7 cases and modifications?

[Loan Modification Company]

An interesting and informative article. Thanks for sharing this post with us.

[Joseph C. McDaniel]

Jonathan,

This is a useful and thoughtful post.

I'm an Arizona bankruptcy lawyer, and this issue hasn't come up in my cases yet, but now I'll keep my eyes open for it.

Fortunately, I've had a lot of folks who had so much debt or primarily non-consumer debt that the means test hasn't been a close issue.

In any case, thanks, and keep up the good work!

[beachdude]

The most common mortgage modifications are listed below:

lowering the mortgage interest rate
reducing the mortgage principal balance
fixing adjustable interest rates within the mortgage
increasing the loan term throughout the mortgage
forgiveness of payment defaults and fees
or any combination of the above

Check out this public service site for more info: http://mortgagemodificationinfo.org

[beachdude]

A Mortgage Modification is a process whereby a home owner's mortgage is modified and both the lender and homeowner are bound by the new terms of the new mortgage.

The most common mortgage modifications are listed below:

lowering the mortgage interest rate
reducing the mortgage principal balance
fixing adjustable interest rates within the mortgage
increasing the loan term throughout the mortgage
forgiveness of payment defaults and fees
or any combination of the above

Check out this public service site at http://mortgagemodificationinfo.org