When a homeowner falls behind on debt and risks losing his home, filing for bankruptcy is often the first thing that comes to mind. Many think it helps increase their chances of getting mortgage aid, particularly in home loan modification. But does bankruptcy really give you an edge in negotiating with your lender, or will it only make the situation worse?

Understanding bankruptcy

Being bankrupt means you're no longer able to pay your creditors. That includes not just your mortgage, but also your credit cards, car loans, student loans, and all the other debts you currently owe. But while a home loan modification only changes your mortgage, the bank takes your total credit into account when evaluating your case. If your debt is large enough to qualify for bankruptcy, your bank may assume a home loan modification won't do much to help.

Bankruptcy and foreclosure

A number of experts say that bankruptcy is at best a delaying tactic for foreclosure. A recent study shows that about 96% of delinquent borrowers who declare bankruptcy still get foreclosed on anyway, so you may end up with both a bankruptcy and a foreclosure on your credit report. If you plan on applying for a home loan modification, try to weigh the advantages of filing for bankruptcy versus the likelihood of a foreclosure.

Costs of bankruptcy

Bankruptcy may help you get rid of debt, but other costs can remain and may even go up. Check your insurance policies to make sure you won't be charged for the bankruptcy, or that they won't have any claims on your property or other assets afterwards. If you're looking to save a certain amount monthly from a home loan modification, take the time to compare it with other costs and see if it makes financial sense.

Debt-to-income ratio

Lenders usually evaluate home loan modification applications based on the ratio of one's monthly income to the amount that regularly goes to debt. Generally, your total debt must not exceed 31% of your monthly income. Bankruptcy may bring your ratio down to a reasonable level, but some banks see it as a negative factor and may still turn down your application.

Credit score impact

Finally, consider how a bankruptcy will affect your credit over the long term. Just like a foreclosure, a bankruptcy usually stays on record for up to 10 years and can get in the way of your future credit decisions. Assuming your home loan modification saves your home from foreclosure, the bankruptcy may affect you just as much.