Facing Foreclosure? How Bankruptcy Can Help
Many Americans fall behind on their mortgage payments. Some lenders and mortgage companies may be willing to work out deals with homeowners, such as a short sale or loan modification. Most lenders are not. Here's how bankruptcy can help when lenders begin the foreclosure process.
When someone falls significantly behind on mortgage payments, a lender will most likely begin the foreclosure process, as set out in the mortgage contract. The foreclosure process involves the creditor repossessing and usually selling the house at a public auction. The proceeds from that auction are used to repay the mortgage and any legal costs.
The foreclosure process takes time. Most creditors do not begin foreclosing until the homeowner is two to three months behind on their mortgage payments. This gives the homeowner some time to consider alternatives to foreclosure, such as loan forbearance, short sale, or deed in lieu of foreclosure. Should all of these alternatives fail (or not be ideal), bankruptcy may help in several different ways. So would contacting a qualified foreclosure attorney for a consultation.
For more information, see The Automatic Stay: Stopping Creditors with Bankruptcy and Is Bankruptcy a Good Idea for You?
Foreclosure vs. Bankruptcy
You may decide to declare bankruptcy or to go through foreclosure depending on a few factors, including your income, debts, and living expenses. The main difference, of course, is that through bankruptcy, you may be able to keep your home.
Here are some other differences between the two:
1. Who Initiates the Case
In cases of bankruptcy, you will be the one starting the process by filing a bankruptcy petition. In foreclosure, the lender is the one who initiates the proceeding to repossess and sell the property.
2. What Happens After the Case
There is a chance you can keep your home after bankruptcy, but this isn't always the case. If you don't have the income to continue paying your mortgage after bankruptcy, you may need to let go of your home.
So why file bankruptcy instead of just accepting the foreclosure?
The main difference between the two is what happens after the sale of the property. In a foreclosure, there is a possibility that you will still owe money to the creditor after the sale if the proceeds of the sale don't cover the debt. In a bankruptcy, however, all debts will be discharged after the case is closed.
3. Who Controls the Property
Once a foreclosure proceeding is initiated, your creditor will have control over the home. But in a bankruptcy, you may be able to retain control of the property until the bankruptcy case is finalized through the "automatic stay" order.
How to Delay Foreclosure With an Automatic Stay
One of the most commonly asked questions is "can filing bankruptcy stop a foreclosure?" If you are facing foreclosure, bankruptcy can become a tool to help you keep your house.
Once you file bankruptcy, either Chapter 13 or Chapter 7, the court automatically issues an Order for Relief. This order grants you an "automatic stay" that directs your creditors to immediately cease their collection attempts, no matter what. So, if a foreclosure sale has been scheduled for your home, it will be postponed, by law, until the bankruptcy is finalized. This usually takes about three to four months.
There are two exceptions to this buying-time rule:
1. If the lender files a motion to lift the stay: The lender can file a motion to lift the stay, which asks permission from the bankruptcy court to continue with the foreclosure sale. If this is granted, you may not receive the extra three to four months of time. However, bankruptcy normally still postpones the sale by about two months or more, or even longer if the lender does not act fast in filing the motion to lift the stay.
2. If the foreclosure notice has already been filed: Most states have laws that require lenders to give homeowners a certain amount of notice before selling their property. A bankruptcy's automatic stay will NOT stop the clock on this advance notice.
For instance, California law requires a lender to give the homeowner at least three months' notice before selling the home. If a California resident receives this three-month notice and then files for bankruptcy two months later, the three-month period would have passed after being in bankruptcy for only one month. As a result, the lender could file a motion to lift the stay and ask the court's permission to schedule the foreclosure.
How to Use Chapter 13 Bankruptcy to Help You
Here's what Chapter 13 means for bankruptcy and foreclosure:
Chapter 13 bankruptcy allows you to set up a repayment plan to pay off the past-due payments, or "arrearage." You can propose the length of time for repayment, but keep in mind that you'll need sufficient income to pay BOTH your past-due payments AND your current mortgage payments at the same time. So long as you make all of the required payments for the length of the repayment plan, you will avoid foreclosure and be able to stay in your home.
2nd and 3rd mortgage payments: Chapter 13 can also help eliminate payments on second or third mortgages. Typically, Chapter 13 entitles bankruptcy courts to recategorize second and third mortgages as unsecured debt. Under Chapter 13, unsecured debt takes last priority and usually does not have to be paid back. This recategorizing process is possible if your first mortgage is secured by the entire value of your home since this means there is no remaining equity in your home to secure the second and third mortgages.
How to Use Chapter 7 Bankruptcy to Help You
Chapter 7 bankruptcy also cancels all the debt secured by the home, including mortgages and home equity loans. Furthermore, Chapter 7 goes a step further. Chapter 7 also forgives the homeowner for tax liability for losses the mortgage or home-improvement lender incurs as a result of the homeowner's default. This law initially applied to the years 2007-2010. But it has been extended five times and now applies to debts forgiven in the years between 2007 to 2020.
However, this tax law does NOT cancel the homeowner's tax liability for the lender's losses at foreclosure if:
- The loan is not a mortgage or was not used for home improvements (like a loan used to pay for a vacation or automobile).
- The mortgage or home equity loan is secured by property other than your principal residence (like a vacation home or rental property).
Cautionary Notes About Chapter 7
You could still lose your home. All of this debt and tax liability forgiveness is great, but note that Chapter 7 will not keep you from losing your home.
Chapter 7 forgives your debt, and that is all it does. When you enter into a mortgage, you are agreeing to use your home as a type of collateral in case you default on your payments.
Chapter 13 enables you to pause action on that lien while you catch up on your payments; hence, you may save your home. Chapter 7 forgives your debt, but it will not lift the lien, and hence will not lift the foreclosure on your home. Therefore, you can still lose your home.
You could lose other valuables: Because the courts typically want to make the creditors whole again from their loss, the bankruptcy trustee may award money from the sale of certain other valuables of yours to the creditors. For example, if you have a valuable wedding ring that's value exceeds the dollar amount you are allowed to keep during bankruptcy under the "jewelry exemption," you could lose your wedding ring.
You may not be eligible: The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 provides that anyone whose average gross income for the six-month period before the bankruptcy filing exceeds the state median income for the same sized household is ineligible for Chapter 7 bankruptcy. Additionally, if your income is sufficient enough for you to pay your living expenses AND fund a reasonable Chapter 13 repayment plan, you are also ineligible for Chapter 7.
How Bankruptcy Will Affect Your Credit
Although bankruptcy and foreclosure are both damaging to your credit, sometimes filing bankruptcy can be a wise choice when trying to rebuild credit.
A foreclosure not only damages your credit score for years, but you are still left with the mortgage debt. Most mortgage creditors will not consider you for future mortgages if you have a foreclosure on your credit history.
In contrast, bankruptcy lets you start fresh. It still damages your credit, but because you are debt-free, you begin rebuilding good credit sooner.
Although bankruptcy has a few negative consequences, and may not save you from losing your home, it can be the best option in starting fresh with no debt, getting back on your feet, and saving money.
Worst Case Scenario: Losing the House, but Also the Debt
Sometimes bankruptcy can't prevent the loss of your home, so you may start to think that a bankruptcy filing is pointless. There are other benefits to filing for bankruptcy besides the interplay between bankruptcy and foreclosure, however.
Even if you can't keep your home, bankruptcy can help to shovel out from under mortgage debts and tax liability. This is an important first step towards getting back on your feet. Bankruptcy can also help you to put away money for the tough times ahead.
Facing Foreclosure? Have a Local Attorney Review Your Legal Options
If you're facing a foreclosure and concerned about your financial future, remember that a bankruptcy filing may help you keep your home or at least soften the blow. You can learn more about your options by meeting with a bankruptcy attorney, who will understand your financial needs and work to make the process as painless as possible. Find a local bankruptcy attorney today.