A question I am asked with increasing frequency is what happens to a mortgage modification negotiation when the borrower files bankruptcy. Of course we all know by now that the answer is that “it depends.”
First, it helps to understand how most lenders staff these situations. There seems to be a common misconception that each loan and lender has a single, intelligent and rational professional banker assigned to it, who is charged with carefully weighing alternative courses of action, making intelligent decisions about each loan on an individual basis and maximizing the bank’s chances of earning the most return on its investment. To that I say “fuggedaboutit.” Most lenders are in complete disarray and wouldn’t recognize a rational business decision on a loan-by-loan basis if it bit them on the nose. Remember, these are the same people that created this fiasco. It seems that the American banking industry has taken Will Rodgers seriously when he said, “If stupidity got us into this, why can’t it get us out of it.” I find it most useful to assume that there is no intelligent life on the other end of a telephone when I call a bank, an assumption which, while cynical, makes life easier by reducing my frustration when Forrest Gump answers.
The people tasked with analyzing and negotiating mortgage modifications are not the same people as those tasked with managing loans that fall into bankruptcy. So when you are negotiating for a possible loan mod and you file bankruptcy, in most cases the whole file gets transferred to someone else’s desk because the bank now has to take certain actions to protect itself that weren’t required pre-petition. They are going to shift into a different mode of “damage control.” That doesn’t mean that the loss mitigation folks can’t talk to you, but a bankruptcy filing is most definitely a game changer. (It is likely that, if you are able to actually negotiate a modification, court approval will be required, but that is a different subject and not within the scope of this post.)
Can you still negotiate a modification? Yes. There is no legal reason why a loan can’t be modified while the borrower is in bankruptcy. Will it happen? That depends on whether the bank keeps the loss mitigation representative involved in the game and talking to you (or your lawyer), and whether that person has a minimal level of motivation and intelligence, or whether they shut that process down.
In a situation I was recently involved in for a client, the lender had first denied the loan mod prepetition because the borrower’s income wasn’t high enough. When he resubmitted with different numbers, the loan mod was denied because he made too much. After the bankruptcy petition was filed, and after the discharge was entered, the lender called me telling me that a loan mod had actually been approved. But when they sent me the documentation, all it was was a new, blank application intended to start the loan mod application process all over again.
Real chances of getting a loan mod are impacted by a lot of different factors, some logical and some which make no sense at all. Bankruptcy may be a factor, but it doesn’t need to drive the end result.