What happens with an upside-down mortgage in bankruptcy?

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We are considering Chapter 7 bankruptcy due to a lot of credit card debt, but we also own a home which we are upside down on. What happens to the house and the mortgage debt?

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If you are upside down on your mortgage (meaning you owe more on your mortgage then your home is worth), what happens to your house and mortgage depends on whether you want to keep the house or not.

Keeping the home. If you want to keep your home and are current with your payments, continue making your payments and your home will be safe. In Chapter 7 bankruptcy the bankruptcy trustee can sell any nonexempt property you have to pay your unsecured creditors. If you're upside down on your mortgage, however, the trustee won't get anything by selling the property, so the trustee won't bother to sell it. (To learn more, see Chapter 7 Homestead Exemption.)

Letting the home go. If you don't want to keep your home and it goes through foreclosure or a short-sale, you may wind up owing the bank money, depending on what state you live in. However, if you file for Chapter 7 bankruptcy, this amount (called a "deficiency") will be discharged.

Cannot make up arrears. It's important to note that Chapter 7 doesn't provide a method for you to catch up on outstanding mortgage payments. So if you are in arrears, you are likely to lose your home to foreclosure unless you can get the lender to agree to a workout.

Your options are different if you file for Chapter 13 bankruptcy. To learn what happens in Chapter 13, see Using Chapter 13 to Avoid Foreclosure.

Updated by: , J.D.

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