Can I Modify My Mortgage in a Chapter 7 Bankruptcy?

Unlike a Chapter 13 bankruptcy, Chapter 7 bankruptcy doesn't have a mechanism that will help you save a house when you're behind on your payments. However, if, after you file for Chapter 7 bankruptcy, your lender agrees to a loan modification (often called a workout), there's nothing in the law stopping you from modifying the loan. But, it will be entirely at your bank's discretion, and your lender will likely want you to wait until it's clear that your trustee has no interest in selling the property for the benefit of your creditors.

The Bankruptcy Estate

If you're a typical Chapter 7 bankruptcy debtor (filer), your case will last four to six months from the date you file until you receive your discharge. During that time, all of your property goes into the bankruptcy estate. You'll still have access and control over your property, but you'll share that control with the bankruptcy trustee appointed by the court to oversee your case.

The Trustee and Your Property

While the house is part of the bankruptcy estate, you can't take any action to sell or encumber it, including modifying the mortgage, without court permission. That's because the trustee must have time to determine whether the creditors are entitled to have your property sold and the proceeds distributed amongst them.

• When the trustee abandons your property. The court control lasts only until the trustee determines that the property has no benefit to the estate and won't be liquidated to pay creditors. The trustee signals this intention by filing a notice with the court "abandoning" the property, or releasing control of the property back to you. If your case isn't complicated, the trustee will often let you know at the 341 meeting the creditors that yours is a no asset case. The trustee abandons the property by filing the no asset report with the court.
• When the trustee doesn't abandon your property. If the trustee doesn't abandon the property, it's likely because it has value that you can't protect with a bankruptcy exemption. The trustee can use nonexempt property to pay off other debts. Here's how it works: Everyone who files a bankruptcy case can protect or "exempt" some property from the reach of the bankruptcy court, including the equity in a house up to a certain value with an exemption. The value of an exemption on a homestead varies from state to state. If the property has more equity than you can exempt, the trustee can sell it and use the proceeds to pay other debts you owe, like medical bills and credit cards. But first, the trustee must pay the mortgage, the costs of sale, and the trustee's commission, as well as give you the amount you're allowed to exempt.

The Modification

The decision to sell the homestead is a serious and sometimes complicated decision that might take some time for the trustee to evaluate. In the meantime, you can apply to your mortgage lender to modify the mortgage (your bank might send a letter to your attorney inviting you to do so). If the lender agrees to the modification, and the trustee hasn't abandoned the property yet, you'll need to do one of two things:

• file a motion asking the court to approve the modification, or
• ask the trustee to file a notice of abandonment of the property.

But there won't be any point in applying if the trustee decides to sell the property. Therefore, don't be surprised if the lender won't take any action on the modification until it's clear that the trustee will abandon the property.

Another Option: Chapter 13 Bankruptcy

If you're in danger of losing your home because you're behind on your payments and need to catch up, or you have a lot of nonexempt equity that a Chapter 7 trustee could use to pay your debts, you might consider filing a Chapter 13 case instead. If you file for Chapter 13 bankruptcy, you can keep your property even if you have nonexempt equity. You'll pay some portion of your debt through a payment plan that will last from three to five years. You can modify your mortgage while you're in a Chapter 13 case, as well.