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. This could be 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 selling the house at a public auction. The proceeds from that auction will 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, bankruptcy may help in several ways.
Foreclosure vs. Bankruptcy
Depending on a few factors, you may decide to declare bankruptcy or go through foreclosure. These factors include your income, debts, and living expenses. The main difference, of course, is that you may be able to experience debt relief and keep your home through bankruptcy.
Here are some other differences between foreclosure and bankruptcy:
1. Who Initiates the Case
In bankruptcy cases, you start 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, you may still owe money to the creditor after the sale if the sale proceeds don't cover the debt. But in bankruptcy, all debts will be discharged after the end of the case.
3. Who Controls the Property
Once a foreclosure proceeding begins, your creditor will generally control the foreclosure process. 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 bankruptcy stop a foreclosure?" If you're 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 cease their collection attempts immediately, no matter what. So, if a foreclosure sale has been scheduled for your home, it will be postponed by law until after the bankruptcy. The bankruptcy process, including finalization, usually takes three to four months.
There are two exceptions to this buying-time rule:
- 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 granted, you may not receive the extra three to four months of time. But bankruptcy usually postpones the sale by about two months or more, or even longer, if the lender doesn't quickly file the motion to lift the stay.
- If the foreclosure notice has already been filed: Most states have laws requiring lenders to give homeowners a certain amount of notice before selling their property. A bankruptcy's automatic stay won't 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 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 simultaneously. So long as you make all of the required payments for the length of the repayment plan, you'll avoid foreclosure and be able to stay in your home.
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 the last priority and usually doesn't have to be returned. This recategorizing process is possible if the entire value of your home secures your first mortgage. This would mean there's no remaining equity in your home to secure the second and third mortgages.
File Chapter 7 Bankruptcy To Help You
In general, if your debt is canceled, forgiven, or discharged for less than the amount owed, the amount of the canceled debt is taxable to you. If taxable, you must report the canceled debt on your tax return for the year in which the cancellation occurred.
Chapter 7 bankruptcy generally cancels all the debt secured by the home, including mortgages and home equity loans. Furthermore, Chapter 7 goes a step further. With Chapter 7, homeowners are generally allowed forgiveness of the income afforded them by this discharge. This law was initially provided as to the years 2007-2010.
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, but that's all it does. When you enter into a mortgage, you're 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. So, you may save your home. Chapter 7 forgives your debt, but it won't lift the lien. It will not lift the foreclosure on your home. So, 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 worth more than the dollar amount allowed 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 for you to pay your living expenses and fund a reasonable Chapter 13 repayment plan, you're also ineligible for Chapter 7.
How Bankruptcy Will Affect Your Credit
Although bankruptcy and foreclosure both damage 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 for 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. You may start to think that a bankruptcy filing is pointless. But there are other benefits to filing for bankruptcy besides the interplay between bankruptcy and foreclosure.
Even if you can't keep your home, bankruptcy can help you dig 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.
Need To Stop Foreclosure? Have a Local Bankruptcy Lawyer Review Your Legal Options
If you're facing a foreclosure, remember that bankruptcy may help you keep your home. You can learn more about your options by meeting with a bankruptcy attorney who is experienced in bankruptcy law and who understands the U.S. Bankruptcy Code. Find a local bankruptcy attorney for quality legal advice today.