I know this sounds completely bizarre, but it may start happening more frequently in the near future.
In the past 30 days, I have encountered three new clients who have been “informally” advised by their mortgage lenders to file bankruptcy to deal with their unsecured debt PRIOR to completing a mortgage modification.
Lenders, in addition to the 31% rule (previously discussed in another post), now appear to be taking a closer look at a homeowner’s total debt ratio – also known in the banking business as the “back end number.”.
In the cases I have encountered thus far, each client had a total debt ratio (mortgage payments, auto payments and credit card minimum payments) of well in excess of 50% of their monthly gross incomes. It is my understanding that lenders may now not consider a homeowner for a modification unless their total debt ratio is less than 40% of their gross monthly income. For many homeowners, bankruptcy may now be the best alternative to eliminate credit card debt BEFORE applying for a mortgage modification.
As a former banker, I know that although the two ratio formula has been around forever, it has shifted over the years. Back in the early ‘90s (before mortgages began to be sold en masse), the rule of thumb was that mortgage debt should not exceed 28% of homeowner’s gross monthly income, AND that their total debt ratio should not exceed 34% of income. In the early 2000’s, the ratios shifted to as high as 35%/45% (and this was in addition to all of the other types of mortgages that were available, such as “liar” loans).
The pendulum now appears to be swinging back to the more “traditional” guidelines. If you are attempting to modify your mortgage, I suggest that you first calculate your total debt ratio and then speak to your lender. Instead of wasting valuable time processing an application for a modification which could be doomed from day one, it may be a good strategy to be proactive with your lender and ask whether they would be willing to consider you for a modification if you agree to deal with your unsecured (credit card) debt in a bankruptcy proceeding. In this environment, anything is possible….