Bruce Wiliams

DEAR BRUCE: About four years ago, a major bank called us about refinancing our mortgage. We agreed, and the bank qualified us for a loan of $1,960 per month. We are on a fixed income -- pension and Social Security for my husband and me -- for a total of about $4,200 per month.

The bank qualified us by "grossing up" our Social Security benefits, which added about $800 to our income. The irony is, we don't have income taxes taken out, and that $800 is an illusion. The bank did not offer escrow with the loan, so we are responsible for taxes and insurance.

Three years ago we did a three-year modification, reducing our payment to $1,390 per month. Still, no escrow for taxes.

Today we are behind three years in our property taxes, our house payment is going back to $1,960 and we are in a mess. We've talked to a bankruptcy lawyer, who recommends Chapter 13 with a payback of three years. I am worried about our house payment, which is about 44 percent of our income. Is bankruptcy our best option, or should we try to work with the bank for a solution to the house payment and back taxes? -- D.G., via email

DEAR D.G.: I am having a problem with a couple of things.

First, when the bank would not establish an escrow account, which is no big deal, why did you not open your own escrow account? This would be a separate account where every month you would deposit money to pay your homeowners insurance and real estate taxes. That would have accomplished the same thing as a bank escrow account. You put yourself into this problem by not taking the responsibility to do that.

In manipulating the mortgage to reduce your monthly payment, you had the advantage of paying less but did not look ahead to when your mortgage would have to return to its previous rate. You've tried to finance your way to solvency through a back door, and that just isn't in the cards. I'm not trying to pick on you, but those are obvious mistakes you made that you don't want to make again.

In considering bankruptcy, you have to discuss what option would be best for you. A Chapter 7 bankruptcy is absolute: The house gets sold and almost all of your debts are discharged. Chapter 13, which you state is what your attorney recommends, is simply a reorganization that gives you time to get back on your feet. While neither is really desirable in terms of credit, Chapter 13 would allow you some breathing room.

I don't think trying to refinance with the bank to get yourself out of debt is the way to go. That whole business right now is so screwed up, I would stay away from it if I possibly could.

Bruce Wiliams

Brucce Williams is a contributor to the Motley Fool.

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