What Happens to Your Mortgage When You File Bankruptcy?

Bankruptcy. The word itself can send shivers down your spine. When financial storms rage, and debt becomes an unbearable burden, bankruptcy can seem like a lifeboat. But what happens to your most valuable asset – your home, and the mortgage tied to it – when you declare bankruptcy? Let’s dive into the turbulent waters of bankruptcy and see how it impacts your mortgage.

The short answer is: filing for bankruptcy doesn’t automatically mean you lose your home. The fate of your mortgage hinges on the type of bankruptcy you file (Chapter 7 or Chapter 13), your ability to keep up with payments, and your intentions regarding the property. There’s no one-size-fits-all answer. This is complex terrain, so let’s unpack it.

Understanding the Bankruptcy Landscape

Before we explore the mortgage implications, let’s establish some ground rules. There are two primary types of bankruptcy relevant to homeowners: Chapter 7 and Chapter 13. Understanding the difference is crucial.

Chapter 7 Bankruptcy: Liquidation

Think of Chapter 7 as a fresh start. It involves liquidating (selling) non-exempt assets to pay off your debts. However, there are exemptions that allow you to protect certain assets, including a portion of the equity in your home.

Chapter 13 Bankruptcy: Reorganization

Chapter 13 is a repayment plan. You propose a plan to the court to repay your creditors over a period of three to five years. You get to keep your assets, including your home, as long as you stick to the plan.

The Mortgage’s Fate Under Chapter 7

So, what really happens to your mortgage in Chapter 7? It breaks down into a few potential scenarios:

• Surrender the Property: You can simply choose to surrender the property to the lender. This relieves you of the debt associated with the mortgage (although potential tax implications may arise from cancelled debt). You walk away, and the lender forecloses.
• Redemption: In rare cases, you might be able to redeem the property by paying the lender the current market value of the home in a lump sum. This is often impossible for individuals facing bankruptcy.
• Reaffirmation Agreement: This is the most common scenario. You sign an agreement with the lender stating that you still owe the debt and agree to be legally bound by the original mortgage terms, even after the bankruptcy is discharged. You must be current on your payments and demonstrate that you can continue to make them. If you default after reaffirmation, the lender can foreclose, and you’ll still be personally liable for any deficiency balance after the sale.

Key Considerations for Chapter 7:

• Exemptions: Each state has different exemption laws. These laws determine how much equity in your home you can protect. If the equity exceeds the exemption limit, the trustee may sell the property to pay creditors.
• The Reaffirmation Gamble: Reaffirming the mortgage can be a good option if you want to keep your home and are confident you can make the payments. However, it’s a gamble. If you default again, you’re back in the same boat.

Navigating Chapter 13 with a Mortgage

Chapter 13 offers a different path. Instead of liquidation, you’re working towards a repayment plan. Here’s how your mortgage fits in:

• Catching Up on Arrears: If you’re behind on your mortgage payments, Chapter 13 allows you to catch up on these arrears over the life of your repayment plan. This is a powerful tool to avoid foreclosure. The arrears are included in your repayment plan and paid off over time.
• Maintaining Current Payments: You must continue to make your regular mortgage payments on time, in addition to the arrears payments included in your repayment plan.
• Lien Stripping: In some cases, you may be able to strip off a wholly unsecured second mortgage or home equity line of credit. This means that if the value of your home is less than the amount you owe on your first mortgage, the second mortgage can be treated as unsecured debt and discharged in the bankruptcy.

Key Considerations for Chapter 13:

• Feasibility: The court must determine that your repayment plan is feasible. This means you have enough income to make all the required payments, including mortgage payments, arrears payments, and other debt payments.
• Plan Compliance: Successfully completing your Chapter 13 plan is crucial. If you fail to make the required payments, the court may dismiss your case, and the lender can proceed with foreclosure.

The Automatic Stay: A Brief Respite

Regardless of whether you file Chapter 7 or Chapter 13, an automatic stay goes into effect immediately upon filing. This stay temporarily halts most collection actions, including foreclosure proceedings. It provides a much-needed breathing space to assess your options and develop a plan. However, the lender can ask the court to lift the stay, allowing them to proceed with foreclosure.

FAQs: Mortgage and Bankruptcy

Here are some frequently asked questions to further clarify the intricacies of mortgages and bankruptcy:

1. Can I still buy a house after filing bankruptcy?

Yes, but it takes time. After a Chapter 7 discharge, you’ll likely need to wait at least two years before you can qualify for a mortgage, and Chapter 13 could be longer. Rebuilding your credit is key.

2. Will bankruptcy affect my credit score?

Absolutely. Bankruptcy is a significant negative mark on your credit report and will substantially lower your credit score. However, it’s a chance to rebuild, and the impact lessens over time.

3. What happens if I reaffirm my mortgage and then default?

If you reaffirm your mortgage and subsequently default, you will be personally liable for the deficiency balance after the foreclosure sale. This means you will still owe the difference between the amount you owed on the mortgage and the amount the house sold for at the foreclosure auction.

4. Can I include my mortgage in my bankruptcy?

Technically, no. You can’t discharge your mortgage like other debts. The mortgage is secured by the property. However, you can surrender the property in Chapter 7 or catch up on arrears in Chapter 13.

5. What is a ‘mortgage modification’ and how does it relate to bankruptcy?

A mortgage modification is an agreement between you and your lender to change the terms of your mortgage, often to lower your monthly payments. Bankruptcy can be a good time to pursue a mortgage modification, as the automatic stay can give you some breathing room to negotiate with the lender.

6. What is the role of a bankruptcy trustee?

The trustee administers your bankruptcy case. In Chapter 7, they liquidate non-exempt assets. In Chapter 13, they oversee your repayment plan and ensure you’re meeting your obligations.

7. Can I sell my house during bankruptcy?

Yes, but it requires court approval. In Chapter 7, the trustee usually handles the sale. In Chapter 13, you’ll need to get permission from the court to sell the property.

8. What happens if I have a second mortgage or HELOC?

Second mortgages and HELOCs are treated differently in Chapter 7 and Chapter 13. As discussed earlier, in Chapter 13, you might be able to strip off a wholly unsecured second mortgage.

9. How do I choose between Chapter 7 and Chapter 13 if I want to keep my house?

The best choice depends on your individual circumstances. Chapter 13 is generally preferred if you’re behind on your mortgage payments and can afford to catch up. Chapter 7 might be an option if you’re current but worried about future affordability.

10. How long does bankruptcy stay on my credit report?

Chapter 7 bankruptcy stays on your credit report for 10 years, while Chapter 13 stays for 7 years.

11. Do I need a lawyer to file bankruptcy?

While you can file bankruptcy without a lawyer, it’s highly recommended to seek legal counsel. Bankruptcy laws are complex, and an attorney can help you navigate the process, protect your assets, and make informed decisions.

12. What is the difference between secured and unsecured debt in relation to bankruptcy?

Secured debt is backed by collateral, like a mortgage (backed by your house) or a car loan (backed by your car). If you don’t pay, the lender can take the collateral. Unsecured debt is not backed by collateral, like credit card debt or medical bills. It’s generally easier to discharge unsecured debt in bankruptcy.

Conclusion

Bankruptcy and mortgages are intertwined in a complex dance. Understanding the nuances of Chapter 7 and Chapter 13, along with your state’s exemption laws, is critical. While bankruptcy can be a daunting prospect, it can also be a lifeline, offering a chance to rebuild your finances and potentially keep your home. Seeking expert advice from a qualified bankruptcy attorney is highly recommended to navigate these challenging waters effectively. Don’t navigate this alone; empower yourself with knowledge and seek professional guidance to make the best decisions for your financial future.