My house is in foreclosure, but I can't afford the payments and don't want to keep it anymore. The house is worth a lot less than what I owe on both the first and second mortgage. Should I file bankruptcy to discharge my liability on the deficiency?
Whether you should file bankruptcy on an underwater home mortgage debt will depend on these factors:
- how your law treats mortgage foreclosure deficiencies
- whether you have other debts you want to discharge in bankruptcy, and
- whether you could and would keep the house if the second mortgage were reduced or eliminated.
(To learn more about how bankruptcy can help with foreclosure, visit our topic area on Bankruptcy and Foreclosure.)
What Is a Mortgage Deficiency?
If your house is sold at foreclosure for less than the outstanding balance of the mortgage loan, there is a deficiency.
Example: If the total debt is $250,000 and the house is sold for $150,000 at the foreclosure sale, the deficiency is $100,000.
Are You Liable for the Mortgage Deficiency?
You may or may not have to pay the deficiency, depending on whether the loan agreement that you signed states that the creditor has the right to collect the deficiency from you (called a recourse loan) or limits the creditor to just selling the house only (called a non-recourse loan).
If you have a non-recourse loan, then the creditor cannot pursue you for the deficiency. In that case, if you do not have other debts worth handling in a bankruptcy, it is not necessary for you to file bankruptcy.
If you have a recourse loan, then you should research the laws of your state (or talk to a knowledgeable attorney) to find out how mortgage deficiencies are treated before considering bankruptcy.
Do Your State's Laws Prohibit or Limit Deficiency Judgments?
If you have a recourse loan, then the creditor could potentially obtain a deficiency judgment against you for the balance of the mortgage loan. However, your state's law may give you additional protection notwithstanding what your loan agreement says. For example:
Not all states allow mortgage creditors to get deficiency judgments on home loans. Other states severely limit the amount of the deficiency judgment, especially if the house is sold at less than fair market value. Mortgage creditors may have a very limited amount of time to file for a deficiency judgment because some states shorten the statute of limitations for home mortgage deficiency judgments.
It May Be Worth Waiting
Usually, mortgage creditors have to file a separate lawsuit to get a deficiency judgment, which happens after the house is sold. You won't know for sure how much the deficiency balance is until the house is sold. Also, many mortgage creditors basically “walk away” after the foreclosure sale and never pursue a deficiency judgment. This means it might be worthwhile to hold off on bankruptcy until the mortgage lender goes after you for the deficiency, especially if you have no other debt you want to discharge.
If, on the other hand, you are fairly certain that there will be a deficiency balance—and you are otherwise eligible to file bankruptcy—then bankruptcy may be a good idea.
Chapter 7 Bankruptcy and Mortgage Deficiencies
A Chapter 7 bankruptcy is probably the most effective way to get rid of the mortgage deficiency. It works by discharging your personal liability (not the liens themselves) on that debt.
Pros of Chapter 7
Filing Chapter 7 to discharge a mortgage deficiency is a good choice if you:
- meet the income requirements and are qualified to file Chapter 7
- have other unsecured, dischargeable debt
- don't own other nonexempt assets that a bankruptcy trustee could seize, and
- are certain that you do not wish to keep the house.
The automatic stay gives you time. If you file Chapter 7 before the foreclosure sale, you have the added benefit of the automatic stay – this can provide you with several additional months to remain in your house rent-free while you save up money, search for a new house, and prepare for the move. (Get more information on the automatic stay in bankruptcy.)
You might be able to get rid of junior mortgages and liens. If you live in Alabama, Florida or Georgia, you may be able to get rid of second and third mortgages and liens. In that case, you should rethink whether you want to give up the house, especially if you can afford to make the payments on the first mortgage only. To learn more, see Can I Remove Junior Mortgages and Liens in Chapter 7?
(To learn more, see Your Home in Chapter 7 Bankruptcy.)
Cons of Chapter 7 Bankrutpcy
Chapter 7 is not a good choice if you:
- earn too much money or are not qualified to file Chapter 7
- own other nonexempt assets that you wish to keep
- have little or no other dischargeable debt, or
- wish to keep the house and have more than one mortgage or other lien on it.
If you fall under this category, then a Chapter 13 may be a good bankruptcy alternative for discharging the deficiency balance.
Chapter 13 and Mortgage Deficiencies
In a Chapter 13 bankruptcy, you can receive a discharge on the deficiency balance by completing a three to five year repayment plan. Your payments are based upon your income and the value of your other assets. So, you may only have to pay a small portion of the deficiency before wiping out the remaining balance.
If the reason you do not wish to keep the house is because you have more than one mortgage and cannot afford the total payments, you may have a way to keep it by making your payments more affordable. That is because a Chapter 13 allows lien stripping on junior mortgages and other liens. This means that second and third mortgages (including home equity credit lines) can be converted to unsecured debt. You would no longer have to pay the full original monthly payment, and instead pay that debt as if it were any other unsecured creditor in your plan. (Learn more about lien stripping in Chapter 13.)
Pros of Chapter 13 Bankrutpcy
Chapter 13 is a good choice if you:
- have other assets that you could lose in a Chapter 7
- make enough income to make the Chapter 13 plan payments for the next three to five years, and/or
- wish to keep the home by lien stripping.
Cons of Chapter 13 Bankrutpcy
Chapter 13 is not always ideal because:
- you must pay something to your unsecured creditors, unlike a Chapter 7
- it lasts much longer than a Chapter 7, and
- you will lose the discharge if you don't make all of the payments, unless you can convert to Chapter 7.
If you are faced with a possible deficiency judgment and bankruptcy is not an option for you, consider these alternatives:
- Seek options under the federal Making Home Affordable Program, especially HAFA. To learn more, visit www.makinghomeaffordable.gov.
- While the foreclosure is still pending, list the property and attempt to sell it as a short sale. You may be able to negotiate with the lender to reduce or eliminate the deficiency. This is difficult if you have more than one lien because you need everyone's consent.
- Before the foreclosure goes to judgment, negotiate a reduction or waiver of the deficiency with the foreclosing bank. The bank may waive the deficiency if you consent to the foreclosure sale because it saves them time and costs.