If you plan to file for bankruptcy but are also facing foreclosure, the timing of your bankruptcy can make a difference for you, depending on what you want to do with your home. In some cases, you should file for bankruptcy first, before the foreclosure sale occurs. In others, it may be better to let the foreclosure run its course, and then file for bankruptcy.
Below you can learn about the benefits and drawbacks for each option.
Bankruptcy's Automatic Stay and the Bankruptcy Discharge
When you file for bankruptcy, an automatic stay goes into effect. This freezes all collection activities against you. A creditor cannot take money or property from you, and any lawsuits against you must pause, during the stay. Even trying to collect through phone calls or letters violates the stay. (Learn more about bankruptcy's automatic stay.)
Once the bankruptcy court enters a discharge at the case’s conclusion, the stay is removed, and creditors whose debts were not discharged (wiped out) by the bankruptcy can resume collection. Bankruptcy eliminates most, but not all, types of debts. The balance due on your mortgage note (often called the deficiency) falls within the category of debts that bankruptcy will wipe out.
When You Should File for Bankruptcy Before the Foreclosure Sale
In some situations, filing for bankruptcy before the foreclosure sale is complete has advantages.
You Want a Mortgage Loan Modification
Many clients in foreclosure want a loan modification, or a similar agreement, with the bank. If you file for bankruptcy early in the foreclosure process, the automatic stay will temporarily stop the foreclosure. When your bankruptcy case is over and the court discharges your debts, the foreclosure will continue. But at that point, you will have time to negotiate a loan modification with the bank before the foreclosure is complete. (Learn about the federal Home Affordable Modification Program.)
One big advantage of having the bankruptcy under your belt: The discharge of your other debts may mean that the bank will be more likely to approve your loan modification.
Peace of Mind
If you don't want to keep your home and your bankruptcy is complete before the foreclosure sale, you won't need to worry about any lingering deficiency balance once the foreclosure goes through. The bankruptcy will eliminate it.
Even if you try to keep the property after your bankruptcy through a loan modification, you'll know that if you don't succeed, you can walk away without owing anything.
You Want More Time in Your Home
If you file for bankruptcy before your home is sold at foreclosure, the automatic stay will prevent the foreclosure case from moving forward. This can add to the time it takes the lender to sell your house, giving you more time to live in it.
You Are Considering Chapter 13 Bankruptcy
In Chapter 13 bankruptcy, you make payments to your creditors over a period of three to five years. In return, you may keep your property.
The benefit of a Chapter 13 if you are in foreclosure is that you may be able to pay off your overdue mortgage payments over the course of your repayment plan. At the end of your plan, you will be current with your mortgage again. You would not have this opportunity if you file for bankruptcy after your home is sold at foreclosure. (Learn more in Using Chapter 13 Bankruptcy to Avoid Foreclosure.)
When You Should File for Bankruptcy After the Foreclosure
Below are some situations where you might want the foreclosure sale to go through, and then file for bankruptcy.
When You Don’t Want to or Can’t Pay Homeowner’s Association or Condominium Dues
You are not liable for payment of dues to a homeowner's association or condominium association if those dues are assessed before your bankruptcy petition is filed. However, you are liable for dues assessed on property in your name after you file for bankruptcy.
If you file your bankruptcy after the foreclosure sale you avoid having to pay dues assessed after you file, because the property is no longer in your name. Any dues that you owe would be those assessed before your filing, and they would be wiped out in your discharge. The same is true for any code violations, fines, or other new charges related to the home.
If You Are Only Filing Bankruptcy to Avoid a Deficiency
If the only reason you are filing for bankruptcy is to avoid a mortgage deficiency balance, you could be jumping the gun by filing before your foreclosure sale because you may not be liable for a deficiency anyway.
What is a deficiency? A deficiency is the difference between how much you owe at the time your home is sold at foreclosure, and its fair market value. For example, if you owe $350,000 on your first mortgage and your home sells for $300,000, the deficiency is $50,000. In many states, the mortgage lender can sue you to collect this amount. (Learn more about deficiency balances after foreclosure.)
Bankruptcy wipes out your personal liability for a mortgage deficiency no matter when you file. But even without bankruptcy, you still might be able to avoid liability for a deficiency. There are a number of situations where borrowers who are foreclosed on do not owe a deficiency:
- State laws. Some states do not allow a mortgage lender to sue former homeowners for a deficiency, at least for certain types of loans.
- Waiver of deficiency. Many lenders will waive (give up their right to) a deficiency in certain situations, especially if you apply for a short sale, deed in lieu of foreclosure, or you have an attorney fighting the foreclosure.
- No collection attempts. And many lenders, even if they obtain a deficiency judgment, won't try to collect it.
If You Have Assets or Property of Value
Many states have laws that allow a debtor to keep more personal property if the debtor does not own a home. You may be able to keep property you otherwise would have lost by filing for bankruptcy after the foreclosure sale, when you no longer own a home.
When You Have No Choice
In many cases, you won't have a choice regarding the timing of your bankruptcy. For example, perhaps you need to file for bankruptcy immediately because of other lawsuits, wage garnishments, or other immediate threats to your money or property. You should always consider your total financial picture when determining the best time to file for bankruptcy. (Learn more about timing your bankruptcy.)