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What is the difference between bankruptcy and a loan modification?

What is the difference between bankruptcy and a loan modification?

Bankruptcy is a section of federal law that enables people who owe money from having to pay it back. Bankruptcy is actually mentioned in the Constitution, and is recognized as a way for people to obtain fresh starts, usually after some catastrophic life event caused them to acquire significant amounts of debt. Studies have consistently shown the leading cause of bankruptcy is due to significant medical bills, job loss, business failure, or family turmoil.

Bankruptcy is the process of having your debts organized and either discharged (legally forgiven), or having them repaid in an organized way over time, or a mixture of both.

In the foreclosure context, Chapter 13 bankruptcy is the tool that enables homeowners to force their mortgage company to accept repayment and causes their loan to become current over time. You basically begin making your normal mortgage payment immediately, plus an extra amount to pay back the accumulated arrears. You will make these payments pursuant to a formal plan overseen by the bankruptcy court, over a period of several years. Once you complete all your payments, the plan is done and your loan is current. You then continue with just your normal mortgage payments.

On the flip side, a loan modification is where you and your mortgage company agree privately to terms that enable you to begin repaying the loan. The process is not part of any formal bankruptcy filing, nor is it overseen by a judge. Instead, a loan modification usually comes from your mortgage company realizing you are facing financial hardship and thus deciding to offer you (or is forced to offer you by the government) a lower interest rate or longer repayment period, which lowers your payment. Alternatively, a loan modification could mean you pay a higher payment for a period of time to repay any arrearages. It could be any combination of a series of terms and is only limited to everyone’s imagination and the existing consumer laws.

In any event, a loan modification is the result of an agreement reached directly between you and your mortgage company, rather than a bankruptcy filing, which is overseen by the bankruptcy court system.

 

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Why Assumable Loans Are Great

Why Assumable Loans Are Great

If you are refinancing or modifying your loan, then I recommend doing what you can to ensure that it is assumable. An assumable loan means someone else can acquire your mortgage (and make payments on it) when you sell the home.

Assumable loan clauses are standard in VA and FHA mortgages, so if you are considering making a change, take a very close look at those programs.

Why look for an assumable loan? Because interest rates are not going to get any lower. In this author’s mind, inflation is just a few short years away, bringing with it higher interest rates. Higher interest rates mean loans are more expensive, and people are not able to buy the size of home they could if rates were lower. You know that your payments are less if your rate is 4% versus 8%. Someone looking to buy your home will be looking at it a lot differently if they have to pay 4% or 8% interest. The difference on a $100,000, 30-Year loan is $403.66 per month. That’s a lot of money.

Getting an assumable loan now at market rates means you can lock in that savings for someone looking to buy your home later, when rates are higher. Because someone assuming your 4% loan will save $403.66 more to spend each month than he would getting a market rate, he should be willing to pay a premium for your home. After all, he’s saving $4,843 per year by taking over your mortgage, or $48,439 over ten years. That means your home is worth more than the next guy who did not think to secure an assumable loan while rates were low.

 

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