Consumers are often surprised to learn that they can modify some secured debts, such as car loans in a chapter 13 bankruptcy. Unfortunately, legislation that would have allowed for debtors to modify first mortgages on their primary residences died this year in Congress leaving homeowners searching for answers. Even lenders that have received bailout funds are still not modifying mortgages…….at least not quickly. I meet with an ever increasing contingency of clients who are unable to get their mortgages modified, despite significant hardship. Fact is that the widespread securitization of residential mortgages has made the loan workout process quite a bit more difficult.

Despite the failure of Senator Durbin’s bankruptcy mortgage modification bill, does chapter 13 bankruptcy still provide a path for borrowers to have first mortgages modified? Let’s examine the ways that secured debt can currently be modified under the Bankruptcy Code.

Modifications of secured debt in chapter 13 plans must conform with the requirements of section 1325(a)(5) of the Bankruptcy Code in order to be confirmed. 1325(a)(5) provides three options for dealing with secured debt: (i) the debtor may surrender the collateral in satisfaction of the claim (any deficiency judgment post creditor liquidation will be treated as unsecured and paid at less than 100%); (ii) the claim may be modified and brought in line with the actual value of the collateral (exluding first mortgages on primary residences) or (iii) the creditor CAN SIMPLY CONSENT TO THE PLAN.

In light of the widespread decline in home values, the third option, creditor consent, has gained appeal. In most circumstances a creditor will not agree to a modification of its claim. As previously mentioned, the Bankruptcy Code does not mandate that a first mortgage securing a consumers primary residence be modified regardless of how underwater the borrower may be. However, it does not prevent a borrower from requesting such a modification through a 13 plan. One of the primary complaints of borrowers in todays housing crisis is an inability to negotiate directly with their lender. Too often, loans have been securitized and the only contact a borrower has is the servicer of the loan. Servicers often have an incentive to see borrowers fall behind on payments per the terms of the securitization documents, so good luck getting them to help. According to Adam J. Levitin’s article in the Harvard Law and Policy Review Online, servicers are sometimes reluctant to engage in modifications for fear of suit by bond holders who believe that modifications hurt their investments and favor other classes of  investors (“tranche warfare”).

The benefit of Chapter 13 is that it can force a lender to at least negotiate a mortgage modification. Once the case is filed, the mortgage company will assign it to an attorney with actual authority to modify the loan. This is no guarantee that a modification will be agreed to, but it advances the borrowers cause by putting her in contact with someone who has the power to change the terms of the note. If negotiations are successful and the mortgage is modified, 1325(a)(5) should mandate a confirmation of the plan under its very first option for modifying secured debt: lender consent. This option would have seemed unrealistic in days past but the current housing crisis has put pressure on lenders to modify mortgages and chapter 13 may be just what the borrower needs to circumvent the beauracracy of their bank.

John O’Connor