When homeowners in California fall behind on their mortgage payments and face foreclosure, they can save their homes by filing Chapter 13 bankruptcies or seeking loan modifications. Chapter 13 bankruptcy was the preferred option before the 2008 financial crisis, but loan modifications became popular when interest rates were reduced during the Great Recession. However, The U.S. Federal Reserve has raised interest rates nine times since March 2022 to combat inflation, and that has made loan modifications less attractive and Chapter 13 bankruptcies more common.
Loan modifications
When mortgage loans are modified, the delinquent payments are normally added to the loan amount. The payment is then reduced by extending the term of the loan and lowering the interest rate. Banks agree to loan modifications to avoid the costs associated with foreclosing on and selling a property, and they actually make more money if all of the payments are made because they collect interest on the homeowner’s arrearages. Modifications make sense for homeowners because they save their homes and lower their payments, but the math does not work when the new interest rate is significantly higher than the original rate.
Chapter 13 bankruptcies
When homeowners who are in danger of losing their homes file Chapter 13 bankruptcy petitions, an automatic stay is issued that puts a halt to foreclosure proceedings. Homeowners then repay their mortgage arrears and other outstanding debts over three or five years with no interest charges. However, they must also continue to make their regular monthly mortgage payments.
Interest rates
If you ever find yourself choosing between a mortgage modification and Chapter 13 bankruptcy, your decision will likely be determined by whether interest rates have gone up or down since you bought your home. If interest rates have fallen since you took out your mortgage, a loan modification could be beneficial. If interest rates have increased, filing for Chapter 13 bankruptcy would probably make more sense.