How Does Bankruptcy Affect Your Mortgage?

Bankruptcy’s impact on your mortgage is complex and nuanced, largely dependent on the type of bankruptcy you file – Chapter 7 or Chapter 13 – and your desired outcome: keep the home or walk away. Generally, bankruptcy doesn’t automatically wipe out your mortgage; it addresses your personal liability to repay the debt. Whether you keep your home depends on your ability to continue making payments and adhere to the terms of your bankruptcy plan.

Understanding the Basics of Bankruptcy and Mortgages

Let’s break down how bankruptcy intertwines with your mortgage, examining both Chapter 7 and Chapter 13 implications.

Chapter 7 Bankruptcy: Liquidation and Your Home

Chapter 7 bankruptcy, often referred to as liquidation bankruptcy, involves selling off non-exempt assets to repay creditors. What happens to your mortgage in this scenario?

• Discharge of Personal Liability: Chapter 7 discharges your personal obligation to repay the mortgage loan. This means that after the bankruptcy is finalized, the lender cannot sue you personally for any remaining debt if you later default and the foreclosure sale doesn’t cover the full amount owed (a deficiency).
• Property Rights Remain: However, the lien on your property remains intact. The mortgage is a secured debt, meaning the lender has the right to foreclose if you stop making payments. Bankruptcy doesn’t erase that right.
• Options for Keeping Your Home: To keep your home in a Chapter 7 bankruptcy, you must be current on your mortgage payments and reaffirm the debt. Reaffirmation is a legal agreement where you agree to remain liable for the debt, despite the bankruptcy. This is a risky move, as you’ll be responsible for the debt even after the bankruptcy discharge.
• Potential Loss of the Home: If you can’t afford the payments or don’t reaffirm the debt, the lender can still foreclose, even though you are no longer personally liable for the loan.
• Exemptions Matter: Many states offer homestead exemptions that protect a certain amount of equity in your home from being liquidated in a Chapter 7 bankruptcy. The specific amount varies by state. If your equity exceeds the exemption limit, the bankruptcy trustee may sell your home to pay creditors.

Chapter 13 Bankruptcy: Reorganization and Your Home

Chapter 13 bankruptcy, also known as reorganization bankruptcy, allows you to create a repayment plan to pay off your debts over a three-to-five-year period. This provides different options for dealing with your mortgage:

• Maintaining Payments: The most straightforward scenario is continuing to make your regular mortgage payments as part of your Chapter 13 plan. This keeps you current and avoids foreclosure.
• Curing Arrears: Chapter 13 allows you to catch up on past-due mortgage payments (arrears) over the life of the plan. This is a significant advantage for homeowners facing foreclosure. You’ll make your regular mortgage payments plus additional payments to cover the arrears.
• Lien Stripping (in some cases): If your mortgage is completely underwater (meaning the property’s value is less than the mortgage balance, and there are other liens on the property), you might be able to strip off a second or subsequent mortgage lien. This essentially converts the second mortgage into an unsecured debt, which is often discharged in bankruptcy. However, this is a complex legal process and not available in all jurisdictions.
• Modifying the Mortgage (rare): While relatively uncommon, it might be possible to modify the terms of your mortgage within a Chapter 13 plan, particularly if you qualify for a government-sponsored modification program.
• The Importance of the Plan: A successful Chapter 13 bankruptcy hinges on your ability to adhere to the terms of the repayment plan. Failure to make payments or comply with the plan can result in dismissal of the bankruptcy and potential foreclosure.

Long-Term Consequences: Credit Score and Future Borrowing

Bankruptcy undeniably impacts your credit score. How does this affect your ability to get a mortgage in the future?

• Credit Score Dip: Both Chapter 7 and Chapter 13 bankruptcies will negatively affect your credit score. The severity and duration of the impact depend on your pre-bankruptcy credit history and how you manage your credit after bankruptcy.
• Waiting Periods: You’ll typically need to wait a certain period before you can qualify for a new mortgage after bankruptcy. For a conventional loan, the waiting period is generally two years after a Chapter 7 discharge and one year after a Chapter 13 discharge. FHA and VA loans may have shorter waiting periods, but these often come with other requirements.
• Rebuilding Credit: The key to future mortgage approval is rebuilding your credit after bankruptcy. This involves making all payments on time, keeping credit card balances low, and avoiding new debt.
• Higher Interest Rates: Even after meeting the waiting period, you might face higher interest rates on a new mortgage due to your past bankruptcy.

Seeking Professional Advice

Navigating bankruptcy and its impact on your mortgage is complicated. Consulting with both a bankruptcy attorney and a financial advisor is crucial. They can assess your individual circumstances, explain your options, and help you make informed decisions.

Frequently Asked Questions (FAQs) About Bankruptcy and Mortgages

1. Will filing bankruptcy immediately stop a foreclosure?

Yes, filing for bankruptcy triggers an automatic stay, which immediately halts most collection actions, including foreclosure proceedings. However, this is often a temporary measure. The lender can petition the court to lift the stay and continue with the foreclosure, particularly if you’re not making mortgage payments.

2. Can I get rid of my second mortgage in bankruptcy?

In some Chapter 13 cases, you might be able to “strip off” a second mortgage if your home is worth less than the balance of your first mortgage and there are no equity in the house to support the second lien. This is a complex process known as lien stripping and requires court approval. It’s generally not possible in Chapter 7.

3. What is a “reaffirmation agreement,” and should I sign it?

A reaffirmation agreement is a legally binding agreement where you agree to remain personally liable for a debt (like your mortgage) even after bankruptcy. While it allows you to keep your home, it also means you’ll be responsible for the debt even if you later default. Carefully consider the risks before signing a reaffirmation agreement.

4. How long does a bankruptcy stay on my credit report?

A Chapter 7 bankruptcy typically remains on your credit report for 10 years, while a Chapter 13 bankruptcy remains for 7 years from the filing date.

5. What happens to my escrow account in bankruptcy?

The treatment of your escrow account depends on the specific circumstances. If you’re reaffirming the mortgage, the escrow account usually continues as normal. If you’re surrendering the property, the lender will typically refund any excess funds in the escrow account to you after the foreclosure.

6. Can I buy a house while I’m in Chapter 13 bankruptcy?

While difficult, it’s possible to buy a house while in Chapter 13 bankruptcy. You’ll need the court’s permission and the approval of the bankruptcy trustee. You’ll likely need to demonstrate that you can afford the mortgage payments and that purchasing a home is in your best interest.

7. What is the difference between surrendering and reaffirming my mortgage in bankruptcy?

Surrendering your home means you’re giving up ownership of the property. The lender will foreclose, and you’ll no longer be responsible for the mortgage debt (though the foreclosure will impact your credit). Reaffirming your mortgage means you’re agreeing to remain personally liable for the debt. You keep the home, but you’re still on the hook if you default in the future.

8. Can a lender deny my mortgage reaffirmation agreement?

Yes, a lender can deny a reaffirmation agreement if they believe you can’t afford the payments or if the terms of the agreement aren’t satisfactory.

9. What if my mortgage lender violates the automatic stay?

If a mortgage lender violates the automatic stay, you may be able to file a motion with the bankruptcy court seeking sanctions and damages against the lender.

10. How can I improve my chances of getting a mortgage after bankruptcy?

The keys to securing a mortgage after bankruptcy are: rebuilding your credit, making all payments on time, saving for a down payment, and demonstrating stable income. Consider secured credit cards and small installment loans to rebuild your credit history.

11. Should I consult with a bankruptcy attorney before making any decisions about my mortgage?

Absolutely. A bankruptcy attorney can provide personalized advice based on your specific situation, explain your rights and options, and help you navigate the complex legal process.

12. Are there government programs to help homeowners facing foreclosure after bankruptcy?

Yes, there are often state and federal programs to help homeowners avoid foreclosure, even after bankruptcy. These may include mortgage modification programs, counseling services, and legal aid. Contacting your state’s housing finance agency or a HUD-approved housing counselor can help you explore available options.