Behind on your Mortgage: Loan Modification or Chapter 13 Bankruptcy?

When a homeowner is behind on their mortgage payment, they may be able to cure their mortgage arrears through a loan modification or by filing Chapter 13 bankruptcy. Which is the better choice depends on the homeowner’s specific situation. In analyzing this type of situation I begin with the interest rate on the existing mortgage. If their interest rate is low and the homeowner is unlikely to get a better rate through a loan modification, then in most cases filing Chapter 13 bankruptcy is the better option.

Chapter 13 bankruptcy will address the debtors’ entire financial situation, including credit cards, medical bills, personal loans, payday loans, etc. A loan modification only addresses the mortgage. Chapter 13 bankruptcy may allow the debtor to cure the mortgage arrears without paying interest on this portion of the debt. Whether the debt can be paid in the Chapter 13 plan without interest depends on the promissory note and the deed of trust. If these documents don’t provide interest on the mortgage arrears then the debtor will be able to pay the arrears in the plan, assuming there is no state law that states otherwise.

So, when is a loan modification the better choice? If obtaining a loan modification reduces the interest rate on the loan then the loan modification is usually the best choice. In this situation, the loan modification will cure the mortgage arrears and usually reduce the homeowner’s monthly payment, making it easier for them to meet their other financial obligations. If the debtor has substantial unsecured debt, they should consider filing Chapter 13 bankruptcy after obtaining the loan modification.