Bankruptcy and loan modifications

When it comes to bankruptcy for the consumer there are two basic kinds, Chapter 7 and Chapter 13. It’s easy to remember the difference between the two because 13 is an unlucky number and you’re unlucky when you have to file a Chapter 13 bankruptcy because you have to make payments on it for the next three to five years.  Whereas, a Chapter 7 Bankruptcy is when you are no longer obligated to pay your debts and they are wiped out.  Lucky number 7!

Chapter 13 bankruptcy was designed to stop foreclosure and may provide protection, relief to save your home, and help you catch up on your past-due debts. Chapter 13 bankruptcy is a reorganization of debts that allows a debtor to make payments to creditors over a period of three to five years. Chapter 13, often referred to as a “wage earner’s bankruptcy”, requires that the debtor have a steady source of income for the duration of the repayment plan.    Nevertheless, many people choose Chapter 13 when filing for bankruptcy because it may allow debtors to keep their home, car, and other types of secured debts. In addition, chapter 13 acts like a consolidation loan under which the individual makes the plan payments to a chapter 13 trustee who then distributes payments to creditors. Individuals will have no direct contact with creditors while under chapter 13 protection.  Before filing for a Chapter 13 bankruptcy people need to think about why they are having problems paying their obligations and realize that with a Chapter 13 bankruptcy all they are doing is spreading their problems out over a period of three to five years.  If you got behind on your mortgage before, what makes you think it won’t happen again if your financial situation has not changed?

Typically, people try to qualify for a Chapter 7 bankruptcy but may fail due to the means test. The Chapter 7 means test is a formula applied to determine whether or not the consumer should have enough money available to make some minimal payment to creditors.  A chapter 7 bankruptcy does not involve repayment of debts as in chapter 13 bankruptcy. Instead, the bankruptcy trustee gathers and sells the debtor’s nonexempt assets and uses the proceeds of such assets to pay creditors in accordance with the provisions of the Bankruptcy Code.  In addition, the Bankruptcy Code will allow the debtor to keep certain exempt property and a trustee will liquidate the debtor’s remaining assets.  As a result of Chapter 7, a loss in property may occur.  A bankruptcy attorney usually has a good idea beforehand what will happen with your assets after filing for bankruptcy.

Bankruptcy will not be behind you until it is discharged. Debtors in a chapter 7 bankruptcy usually receive a discharge within 60 to 90 days after the date first set for the meeting of creditors.  On the other hand, a chapter 13 bankruptcy won’t be discharged until all scheduled payments are made to the trustee which could take up to five years.  Because a chapter 13 bankruptcy is not discharged until the last scheduled payment is received, this will negatively affect your credit for the three to five years until it is discharged.  Don’t expect to purchase a home with a mortgage until your chapter 13 bankruptcy is discharged and you might be looking at an additional couple of years after that.  When filing a chapter 13 bankruptcy you could be looking at five to seven years before being able to mortgage a home.  With a chapter 7 bankruptcy you are able to put the bankruptcy behind you faster and generally will be able to mortgage a home quicker than a chapter 13.  After filing for either bankruptcy, don’t expect to mortgage a home for at least four years and that is if you are able to reestablish your credit.

Let’s recap, a chapter 13 is used when you are wanting to catch up on your mortgage payments and want to pay your creditors back over the next three to five years.  A chapter 7 bankruptcy is helpful when you don’t want to pay your creditors back. With the new Making Home Affordable Program (HAMP), you can now have the best of both worlds but even better.  You can modify your mortgage with HAMP and this will restructure your mortgage, catch you up on back payments, and lower your mortgage payment to one that is affordable.  After getting a loan modification you could then file for a chapter 7 bankruptcy and then you’re getting the best of both worlds with a new lower mortgage payment.

This article is the ninth of a Do-It-Yourself approach to home loan modifications. Check back often or subscribe to this site to stay tuned for the next article in this series (a new post will come out each week day for a month), designed to help you complete a loan modification on your own, cutting out the middle man, helping you protect your ability to stay in your home for the best price possible, and helping you lower your payments as much as possible. After all, nobody will look out for you as well as you can look out for yourself.

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