Home > Mortgages > When to Say No To a Mortgage Modification

Comments 0 Comments

No!You read the headline right. As shocking as it may sound, sometimes it may in fact make sense to say no to a mortgage modification, even when your house in underwater.

As you may have heard, some of the nation’s biggest lenders will be offering loan modifications to their customers, and some of those deals will include reducing the amount the borrower owes, a.k.a. “principal reductions.” It’s part of a multi-state settlement struck with some of the nation’s largest lenders, including Ally Financial, Bank of America, Citigroup, JPMorgan Chase, Citigroup and Wells Fargo. (It has not been finalized.)

While some of those principal reductions will be too small to put homeowners above water, the Huffington Post reports that Bank of America will be offering to write down the loans of more than 200,000 underwater homeowners to market value.

[Credit Calculator: Use Credit.com’s Free Credit Report Card]

Sounds like a good deal? Not so fast. There are times when a loan modification may make things worse.

If you have a second mortgage and your first mortgage is entirely underwater, then your second mortgage is essentially unsecured. In many cases, these second mortgages can be “stripped,” or wiped out, in bankruptcy. But if the lender reduces the balance owed on a first mortgage, then the second mortgage may no longer qualify for this relief.  Connecticut bankruptcy attorney Eugene Melchionne explains:

…if there is even a penny of value in the home that would go to a second mortgage when the property was sold, the loan cannot be valued as unsecured.  That means it must be paid during the Chapter 13 case and it also survives the Chapter 13 as a lien on the property until it’s paid off. (Source: Bankruptcy Law Network)

To illustrate, suppose you have a first mortgage of $150,000 with Lender A and a second mortgage for $50,000 with Lender B. You owe a total of $200,000, but your home is worth only $125,000. Let’s say Lender A writes down your balance to $124,500. Now your first loan is no longer underwater. However, your second loan still puts you underwater to the tune of $45,500.


Credit Report Card
Check your credit for free with this great tool from Credit.com. It offers expert advice on how to manage your credit. And you can return every 30 days for unlimited free updates.
Sign Up Here »

[Featured Products: Research and Compare Mortgage Rates at Credit.com]

However, let’s say that instead, you file for bankruptcy and wipe out the $50,000 second mortgage. You still are underwater on the first by $25,000, but you’re better off than you were if you took the loan modification.

Either way, though, you’re still at risk of drowning financially.

There is a third alternative that may solve that problem. Melchionne explained to me that there is nothing to stop a loan from being modified during a Chapter 13 bankruptcy, after the second has been stripped. So in that scenario, you file Chapter 13 bankruptcy, wipe out the second loan of $50,000 then work with the lender to try to get a loan modification on the first that will bring you back onto solid ground again.

Another reason you may want to think twice before you accept your bank’s loan modification? Taxes. I’ve been writing a lot lately about the nightmare that is created when lenders report cancelled debt to the IRS. When a lender forgives part or all of a loan balance totaling $600 or more, that “income” must be reported to the IRS on Form 1099-C. You may be able to avoid paying taxes on that income, if you qualify for an exclusion. But if you don’t, you could find yourself with a hefty tax bill.

[Related Article: Slew Of Tax Tips To Clean Your 1099-C Mess]

In the case above, where Lender A writes down the balance on the loan by $25,000 or more outside of bankruptcy, that debt could turn into “income” that could in turn, result in a tax bill of several thousand dollars, depending on the taxpayer’s tax bracket.  Debts discharged in bankruptcy, however, are not taxable.

Sound complicated? It is. But that’s why it is important to get good advice, and meeting with  a bankruptcy attorney would be the place to start. But timing is crucial, and missteps can be costly. So before you accept your mortgage lender’s offer to modify your loan, tell the lender you have to consult your attorney first.

 Image: Marc Falardeau via Flickr

Comments on articles and responses to those comments are not provided or commissioned by a bank advertiser. Responses have not been reviewed, approved or otherwise endorsed by a bank advertiser. It is not a bank advertiser's responsibility to ensure all posts and/or questions are answered.

Please note that our comments are moderated, so it may take a little time before you see them on the page. Thanks for your patience.

Credit.com receives compensation for the financial products and services advertised on this site if our users apply for and sign up for any of them.

Hello, Reader!

Thanks for checking out Credit.com. We hope you find the site and the journalism we produce useful. We wanted to take some time to tell you a bit about ourselves.

Our People

The Credit.com editorial team is staffed by a team of editors and reporters, each with many years of financial reporting experience. We’ve worked for places like the New York Times, American Banker, Frontline, TheStreet.com, Business Insider, ABC News, NBC News, CNBC and many others. We also employ a few freelancers and more than 50 contributors (these are typically subject matter experts from the worlds of finance, academia, politics, business and elsewhere).

Our Reporting

We take great pains to ensure that the articles, video and graphics you see on Credit.com are thoroughly reported and fact-checked. Each story is read by two separate editors, and we adhere to the highest editorial standards. We’re not perfect, however, and if you see something that you think is wrong, please email us at editorial team [at] credit [dot] com,

The Credit.com editorial team is committed to providing our readers and viewers with sound, well-reported and understandable information designed to inform and empower. We won’t tell you what to do. We will, however, do our best to explain the consequences of various actions, thereby arming you with the information you need to make decisions that are in your best interests. We also write about things relating to money and finance we think are interesting and want to share.

In addition to appearing on Credit.com, our articles are syndicated to dozens of other news sites. We have more than 100 partners, including MSN, ABC News, CBS News, Yahoo, Marketwatch, Scripps, Money Magazine and many others. This network operates similarly to the Associated Press or Reuters, except we focus almost exclusively on issues relating to personal finance. These are not advertorial or paid placements, rather we provide these articles to our partners in most cases for free. These relationships create more awareness of Credit.com in general and they result in more traffic to us as well.

Our Business Model

Credit.com’s journalism is largely supported by an e-commerce business model. Rather than rely on revenue from display ad impressions, Credit.com maintains a financial marketplace separate from its editorial pages. When someone navigates to those pages, and applies for a credit card, for example, Credit.com will get paid what is essentially a finder’s fee if that person ends up getting the card. That doesn’t mean, however, that our editorial decisions are informed by the products available in our marketplace. The editorial team chooses what to write about and how to write about it independently of the decisions and priorities of the business side of the company. In fact, we maintain a strict and important firewall between the editorial and business departments. Our mission as journalists is to serve the reader, not the advertiser. In that sense, we are no different from any other news organization that is supported by ad revenue.

Visitors to Credit.com are also able to register for a free Credit.com account, which gives them access to a tool called The Credit Report Card. This tool provides users with two free credit scores and a breakdown of the information in their Experian credit report, updated twice monthly. Again, this tool is entirely free, and we mention that frequently in our articles, because we think that it’s a good thing for users to have access to data like this. Separate from its educational value, there is also a business angle to the Credit Report Card. Registered users can be matched with products and services for which they are most likely to qualify. In other words, if you register and you find that your credit is less than stellar, Credit.com won’t recommend a high-end platinum credit card that requires an excellent credit score You’d likely get rejected, and that’s no good for you or Credit.com. You’d be no closer to getting a product you need, there’d be a wasted inquiry on your credit report, and Credit.com wouldn’t get paid. These are essentially what are commonly referred to as "targeted ads" in the world of the Internet. Despite all of this, however, even if you never apply for any product, the Credit Report Card will remain free, and none of this will impact how the editorial team reports on credit and credit scores.

Your Stories

Lastly, much of what we do is informed by our own experiences as well as the experiences of our readers. We want to tell your stories if you’re interested in sharing them. Please email us at story ideas [at] credit [dot] com with ideas or visit us on Facebook or Twitter.

Thanks for stopping by.

- The Credit.com Editorial Team