Mortgage Modification Or Chapter 13 Bankruptcy: Which Comes First?

Some of my bankruptcy  clients are considering Chapter 13 bankruptcy to save their homes and strip off a second mortgage. These people are simultaneously investigating a modification of their first mortgage through one of the mortgage modification programs offered by their mortgage lender and the government’s mortgage initiatives. The clients are unsure whether they should file Chapter 13 and negotiate a mortgage modification in Chapter 13 mortgage mediation, or to fully explore a modification program before filing bankruptcy. Many are concerned that filing Chapter 13 bankruptcy will reduce chances of their lender accepting a mortgage modification. 

I recommend usually filing Chapter 13 bankruptcy first and then trying to modify the first mortgage within bankruptcy courts’ mortgage mediation programs. The main reason is that a mortgage modification pre bankruptcy which reduces their first mortgage balance may disqualify the clients from stripping the second mortgage. 

Chapter 13 bankruptcy can strip a second mortgage on the debtor’s primary residence only if the house is worth less than the first mortgage balance. Some mortgage modifications reduce principal balance to the fair market value of the house. If the homeowner enters into a modification in which the lender agrees to reduce the first mortgage principal balance the debtor may end up with a house equal to or just greater than the modified first mortgage. In that event, the homeowner could not proceed to file bankruptcy and strip the second mortgage; the first mortgage modification will have enhanced the second mortgage security.

On the other hand, if the house is upside down on the first mortgage when the homeowner files bankruptcy he is eligible to strip the second mortgage. The mortgage balance and house value on the date of filing govern the second mortgage strip. Subsequent changes to the first mortgage during the bankruptcy mediation should not disqualify the strip of the second mortgage in the Chapter 13 plan.