Using Bankruptcy When Facing Foreclosure

Can a home be foreclosed after bankruptcy? Is there any difference between a foreclosure before or after bankruptcy? How does bankruptcy help borrowers avoid foreclosure?

If you’re in foreclosure and thinking about bankruptcy, you probably have a lot of questions. For example, you may be wondering: Will bankruptcy help me keep my home? Do I still have to make mortgage payments after I file for bankruptcy? Will my lender still be able to foreclose even after I file for bankruptcy?

Filing bankruptcy may be a viable option to buy some extra time, but it may not be a permanent foreclosure fix unless you are able to continue to make mortgage payments. Understanding what will happen to your home following a Chapter 7 or Chapter 13 filing can help you make an informed decision about choosing to declare bankruptcy.

The Automatic Stay

If a bankruptcy is filed before a foreclosure is initiated or before the foreclosure is completed, something called an automatic stay will bar your lenders from continuing their collection activities and will delay a pending foreclosure. The stay is effective as of the date the bankruptcy is filed. However, if you stop or have already stopped making mortgage payments, the lender may choose to file a motion for relief from stay. If the bankruptcy grants the motion, the lender will be allowed to proceed with the foreclosure. Alternatively, the lender may decide to wait to proceed with the foreclosure after the bankruptcy case has been completed.

The Bankruptcy Discharge

Most debtors who file for bankruptcy do so to obtain a discharge, or release, from personal liability for certain types of debts. With a Chapter 7 bankruptcy, the discharge is normally given once the time for creditors to object to the discharge (or to file a motion to dismiss the case for substantial abuse) has expired, usually around four months after the bankruptcy is filed. With a Chapter 13, the discharge will be granted after completion of the payment plan, which is generally three to five years in duration.

A bankruptcy discharge of a mortgage debt eliminates the personal liability for that debt. (Keep in mind, however, that even though the borrower is no longer personally liable for the mortgage debt, the lender still has the right to foreclose if the borrower isn’t making mortgage payments. See “Foreclosure of the Mortgage Lien,” below.) As a result, the borrower cannot later be held responsible for repaying the deficiency (the difference between the outstanding mortgage debt and the foreclosure sale price) following a foreclosure. In some states, lenders are able to sue homeowners for this difference and obtain a deficiency judgment, which is a personal judgment against the borrower. Lenders cannot get a deficiency judgment if the borrower’s mortgage debt was discharged in bankruptcy.

Foreclosure of the Mortgage Lien

While the bankruptcy discharge eliminates the borrower’s personal liability for the mortgage debt, it does not wipe out the lien that was recorded against the property.

A mortgage obligation consists of two parts: a promissory note and a mortgage (or deed of trust in some states). The promissory note is the personal promise to pay back the money borrowed to purchase the property. This obligation is what is eliminated by a bankruptcy discharge. The mortgage or deed of trust, on the other hand, establishes the lien on the property.

Though the bankruptcy discharge will eliminate the personal obligation under the promissory note, it will not wipe out the mortgage lien that encumbers the real estate. As a result, the lender may still foreclose its lien once the automatic stay is lifted or once the bankruptcy is complete if the borrower has defaulted on payments.

Reaffirmation of the Mortgage Debt

As part of a Chapter 7 bankruptcy, a borrower may choose to sign a reaffirmation agreement for a debt. A reaffirmation agreement is an agreement to repay all or a portion of a debt that otherwise could have been discharged. With a mortgage loan, a reaffirmation agreement reestablishes the borrower’s liability for the mortgage; the borrower agrees to remain personally responsible for repaying the mortgage debt even after bankruptcy. By signing a reaffirmation agreement for the mortgage, the borrower also agrees to be subject to a deficiency judgment (if state law allows) in the event that the borrower again defaults on the mortgage.

In most cases, it is not necessary to sign a reaffirmation agreement to keep your home as long as you remain current on the payments before, during, and after the bankruptcy. With a Chapter 7 bankruptcy, you can simply keep making mortgage payments directly to the lender. This way, if you later default on mortgage payments after the bankruptcy is complete (and a discharge of the mortgage debt is granted), then the lender may foreclose but will not be able to sue you to recover the deficiency.

To keep your home with a Chapter 13 filing, mortgage payments will be made as part of your bankruptcy payment plan; you’ll either pay the bankruptcy trustee or your lender directly. When the bankruptcy is over, if you continue to make mortgage payments, the lender won’t foreclose and you will be able to keep your home permanently.

When to Seek Counsel

There are many legal complexities involved with both bankruptcy and foreclosure. If you are facing foreclosure and contemplating filing for bankruptcy, it may be a good idea to consult with a qualified attorney to help you through the process and ensure that you fully understand all of your rights under the law.

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