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The downturn in the economy has caused real estate values to decline.  In the wake of this real estate crisis, many loss mitigation alternatives relative to real estate mortgages have emerged. These include mortgage modification programs.You may have heard about the government Home Affordable Modification Program or “HAMP.”  This program has been in existence for the last few years since October 2008.  HAMP is the government sponsored modification program.  Many borrowers have tried on their own to obtain a HAMP modification for the mortgage on their principal residence, but have become so frustrated that they ultimately give up.

The Florida Supreme Court issued an administrative order which requires mandatory real estate mortgage foreclosure mediation. The idea is to get borrowers and banks to sit down at a face to face meeting to discuss mortgage foreclosure alternatives.  However, the ultimate result typically falls short of a permanent modification.  This article explores the procedure of requesting a loan modification through a Chapter 13 bankruptcy, and the differences between proceedings in bankruptcy court versus state court.

The standing Chapter 13 Trustee in the Orlando division of the Middle District of Florida Bankruptcy Court has championed mortgage modifications in Chapter 13 bankruptcy. This has resulted in successful permanent modifications in that division. The process is now beginning to take place in the Tampa division of the Middle District with some division differences.

Chapter 13 is reorganization or rehabilitation for individuals filing for bankruptcy who are wage earners.  This section of the code requires debtors to commit their disposable income available on a monthly basis to their general unsecured class of creditors (credit cards, medical bills, etc.).  Chapter 13 bankruptcies, unlike the Chapter 7 liquidation bankruptcy, allows for a second mortgage to be avoided or “stripped off” as an encumbrance against the real estate under certain circumstances.  Once stripped off this debt is lumped into the general unsecured class of creditors and will receive a pro rata distribution through the life of the reorganization plan.

This avoidance process can only be achieved through a Chapter 13 bankruptcy filing and is not available in state court. Therefore, potential debtors whose principal residence is extremely over leveraged could benefit from the avoidance action in the Chapter 13.  This process combined with a permanent modification of the first mortgage on their principal residence can make it more feasible for debtors to retain their home.  Unfortunately, cramdown of a first mortgage on a debtor’s principal residence is not available currently under the bankruptcy code.

 

Filing bankruptcy can make a modification more attractive to the bank because the borrower-debtor has discharged much of their unsecured debt in bankruptcy and can prevent a re-default by the borrower-debtor.  For instance, outside of bankruptcy, unsecured debts must continue to be serviced by the borrower.  If the borrower cannot continue to remain current and receives a judgment followed by garnishment of their wages will directly affect the borrower’s ability to pay even a modified mortgage.  One can speculate that this is a factor in the decision not to permanently modify loans for borrowers outside of bankruptcy.

So how does it work?

Factors to consider before filing bankruptcy with the purpose of obtaining a modification include determining the value of the real estate, so that a determination of whether or not the second mortgage lien can be avoided. Next, the borrower’s income must be analyzed to determine if their current first mortgage payment (PITI and HOA dues) exceeds 31% of their gross income.  Their income sources must be identified and determined to be consistent.  The home must be the debtor’s primary residence for those seeking modification.

File the Chapter 13 bankruptcy and use the updated model Chapter 13 plan which now includes a provision to make proposed modified payments of 31% of the debtor’s gross income as ongoing temporary modified mortgage payments.  This achieves two things in bankruptcy:  First, it demonstrates that the debtor can make a modified payment and this payment is part of the Trustee payment paid on a monthly basis to the Chapter 13 trustee in the case. Second; it prevents the bank from obtaining relief from stay for a six month period to provide for more time to work out the modification.  The proposed payments under the plan are considered adequate protection payments to the bank or secured lender and can prevent them from obtaining relief so that they can proceed to state court and foreclose.

Next, debtor’s counsel will file a Motion for Referral to Mediation for Mortgage Modification and the court will appoint a mediator.  The court in the Tampa division requires the mediator fee which typically costs $350.00 for two hours to be split evenly between the creditor and the debtor.  The Motion and Order contains within it specific hard deadlines for exchange of paperwork and identification of the parties attending the mediation with the authority to settle the matter.

This mediation can occur months after filing, however, some creditors may consider the adequate protection payments made to the Trustee as temporary payments and may be able to move to a permanent modification at mediation.  If this is not the case, the creditor can outline the temporary payment schedule and a time certain as to when the permanent modification will take effect.  This may require the debtor’s attorney to request an extension of the automatic stay protection. If an order confirming the Chapter 13 plan is entered by the court, a modification of that order will be required when the permanent modification occurs after the entry of the confirmation order.  Once the debtor completes all payments under the Chapter 13 plan, they emerge with their permanent modification intact, typically, less a second mortgage and continue to stay in their home.