Using Bankruptcy When Facing Foreclosure

If you're in foreclosure and thinking about filing for bankruptcy, you probably have a lot of questions. You might 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 be able to foreclose even after I file for bankruptcy?

Filing for bankruptcy might be a viable option to buy some extra time in the property. But it might not be a permanent foreclosure fix unless you're able to continue making your mortgage payments or you can get the loan modified so that the payments are more affordable.

Understanding the basics about how bankruptcy works and 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.

Will a Bankruptcy Stop a Foreclosure?

If you file for bankruptcy before the bank starts a foreclosure or before the foreclosure ends, an automatic stay will prevent creditors from initiating or continuing collection activities and will delay a pending foreclosure. The stay is effective as of the date the bankruptcy is filed.

But if you stop making your mortgage payments, or you're already behind, the lender might choose to file a motion for relief from stay. If the bankruptcy court grants the motion, the lender will be allowed to proceed with the foreclosure. Or the lender might decide to wait to go ahead with the foreclosure until after the bankruptcy case has been completed.

The Bankruptcy Discharge

Most debtors who file for bankruptcy do so to get a discharge, or release, from personal liability for certain types of debts.

How Chapter 7 Bankruptcy Discharges Work

With a Chapter 7 bankruptcy, the discharge normally happens 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 a couple of months after the bankruptcy is filed.

How Chapter 13 Bankruptcy Discharges Work

With a Chapter 13 bankruptcy, the discharge will be granted after completion of the payment plan, which is generally three to five years long.

How Bankruptcy Affects Your Mortgage Loan

A bankruptcy discharge for a mortgage loan eliminates the borrower's personal liability for that debt. After a mortgage debt is discharged, the borrower can't later be held responsible for repaying the deficiency.

What Is a Deficiency Judgment?

In some states, a foreclosing lender can sue the homeowners for the difference between the outstanding mortgage debt and the foreclosure sale price and get a deficiency judgment. A "deficiency judgment" is a personal judgment against the borrower. But the lender can't get a deficiency judgment if the borrower's mortgage debt was discharged in bankruptcy.

Foreclosure of the Mortgage Lien

Even though a borrower isn't personally liable for the mortgage debt after a discharge, the lender still has the right to foreclose if the borrower isn't making payments. While the bankruptcy discharge eliminates the borrower's personal liability for the mortgage debt, it doesn't wipe out the lien that was recorded against the property.

How Mortgage Liens Work

A mortgage obligation consists of two parts: a promissory note and a mortgage (or deed of trust).

What is a promissory note? The promissory note is the personal promise to pay back the money borrowed to purchase the property. This obligation is what's eliminated by a bankruptcy discharge.

What is a mortgage or deed of trust? The mortgage or deed of trust, on the other hand, establishes the lien on the property.

Although a bankruptcy discharge will eliminate the personal obligation under the promissory note, it won't wipe out the lien that encumbers the real estate. So, 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.

Filing for Chapter 7 Bankruptcy

By filing a Chapter 7 bankruptcy, if you qualify, you can probably keep the home if you're current on your mortgage payments and you don't have much equity in the property. But you'll likely lose the home in the bankruptcy (which happens when the bankruptcy trustee sells your home to pay off creditors) if you have significant equity.

Also, if you're behind on your mortgage payments, you'll likely eventually lose your home to foreclosure, even if the bankruptcy trustee doesn't sell the home. If you're planning on letting the home go in foreclosure, filing for Chapter 7 bankruptcy can delay foreclosure for a short period.

Filing for Chapter 13 Bankruptcy

In a Chapter 13 bankruptcy, the debtor pays all or a part of debts over time through a repayment plan. With this kind of bankruptcy, you can pay off a mortgage arrearage over the duration of the repayment plan, typically three or five years, depending on your income and the time it will take you to meet all the plan's requirements.

Filing for Chapter 13 bankruptcy can be especially helpful if you're behind in mortgage payments, want to keep your home, and need time to get current on payments.

When to Seek Counsel

Many legal complexities are involved with both bankruptcy and foreclosure. If you're facing foreclosure and contemplating filing for bankruptcy, it's 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 and options under the law.