The House recently approved a bill allowing bankruptcy judges to lower mortgage payments for struggling homeowners. This is certainly good news for the 5.4 million homeowners who were in default by the end of last year. But how can it really benefit struggling borrowers? What change does it really make for you? This guide answers a few basic questions.

What’s the difference?
The biggest difference the bill makes is that home loans are now included in the program. Prior to the bill, bankruptcy judges could only modify student loans and car loans (among others), and mortgage loan modifications were clearly excluded. With the new legislation, you can apply for Chapter 13 bankruptcy and get your loan modified, either with a lower interest rate or a reduction of the principal.

How much can I save with the new plan?
The bill is designed to reduce the debt-to-income ratio (DTI) of borrowers with troubled mortgage loans. The DTI refers to the portion of your income that goes into mortgage expenses, including interest and insurance premiums. The government aims to bring DTIs down to a comfortable rate of 31%, which most defaults have exceeded. If your DTI is over the limit, your lender must first agree to bring it down to 38%, and the government will split the costs to further reduce it to 31%.

What are the limits?
Critics have pointed out that as more people file for bankruptcy, mortgage rates will go up and be more detrimental in the long run. To address the issue, Housing Secretary Shaun Donovan worked out a compromise limiting the bankruptcy option to homeowners who have previously sought other means of assistance. What this means is that you should take the initiative and work out alternative solutions with your lender before resorting to Chapter 13 bankruptcy. And when you come to your lender asking for a bankruptcy loan modification, you’ll have to give them 30 days to draw up an alternative. If your lender’s offer doesn’t bring your DTI to the 31-percent limit, you can still apply for bankruptcy and get a loan modification.

What if you got your current loan without proper paperwork? You can still apply for a bankruptcy loan modification, but the court will require a good-faith statement stating your plan for repaying the loan. You will also need to provide complete documentation. This keeps the option open to people who qualified for their loans without complete documentation, but retains a measure of security for both the courts and the lenders.

But will the lenders participate?
Banks and credit unions can choose whether or not to take part in the program, but the bill is designed to make loan modification and other workouts a more attractive option. For one thing, the government offers incentives for lenders who offer workouts according to the Hope for Homeowners loan modification program. Participating lenders will have their federal insurance increased from $100,000 to $250,000.

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