Although Chapter 7 bankruptcy can temporarily stop foreclosure proceedings, it's ability to ultimately save your home from foreclosure is limited. Below you can learn how your mortgage is treated in Chapter 7 bankruptcy, why Chapter 7 isn't usually the best way to save your home, and the limited ways that Chapter 7 may help if you are in foreclosure.
Chapter 7 bankruptcy allows you to completely wipe out most of your debts. The bankruptcy court will evaluate your income and your assets, and if you qualify, will enter a discharge. The discharge forever eliminates most of the debts that you owe.
Chapter 7 wipes out the amount that you owe on your mortgage note. However, bankruptcy only eliminates what you personally owe on the note. It does not eliminate or wipe out the mortgage lien. This means that if you are behind in mortgage payments, your lender can foreclose (or continue a foreclosure case that was pending when you filed bankruptcy), once your discharge is entered. The same is true for other liens, such as condominium or homeowner association liens.
However, if you are current on your mortgage when you file the Chapter 7 bankruptcy, most bankruptcy courts allow you to keep paying your mortgage, and continue to retain your home if you so choose.
However, because you are not personally liable for the mortgage after you receive your bankruptcy discharge, you will not be on the hook for a deficiency balance after foreclosure. (If you owe more on the loan than the home is worth, the difference is called the deficiency. Absent bankruptcy, in many states the lender can come after you for payment of this amount.)
The bottom line: If you want to avoid liability for a deficiency judgment, Chapter 7 bankruptcy can help. But if you are trying to keep your home, or stop a foreclosure, its effectiveness is much more limited.
If you are behind on mortgage payments, Chapter 7 bankruptcy is not usually the best way to save your home. Here's why.
Chapter 7 bankruptcy does not have a mechanism for you to catch up on the payments you are behind on your mortgage through your bankruptcy case. The bankruptcy court likewise cannot compel your mortgage company to work out any kind of repayment plan with you.
Lien stripping is the ability for a court to completely eliminate a mortgage lien when the value of the property would not be high enough at foreclosure sale to pay any money towards the lien. This is most often the case with second liens and home equity lines.
Lien stripping is available in Chapter 13 bankruptcies, but most bankruptcy courts around the country have rejected the idea of “lien stripping” in Chapter 7 bankruptcies. Some circuits have allowed debtors to strip lines in Chapter 7, but most courts do not follow this precedent, and in fact, the United States Supreme Court is considering whether to issue a ruling on this point in the future.
Contrary to what some believe, there are also no laws that require lenders to modify loans in bankruptcy, nor which provide a bankruptcy court the power to compel loan modifications.
Although Chapter 7 is not usually the best way to save your home from foreclosure, there are things it can do to help struggling homeowners.
The biggest benefit that a Chapter 7 bankruptcy can provide if you are in foreclosure is a temporary reprieve of foreclosure proceedings through the automatic stay.
Once a bankruptcy is filed, an automatic stay goes into effect. The stay immediately prohibits most creditors from taking any actions to collect from you. This includes phone calls, pursuing litigation, or taking your property through repossession or foreclosure. A bankruptcy court can severely punish any creditor who tries to collect a debt from you after you have filed for bankruptcy.
In foreclosure, the stay also means that foreclosure activities will temporarily cease, and if your home is scheduled for a foreclosure sale, the sale will be cancelled and will not be able to be reset until after the bankruptcy. An uncontested Chapter 7 bankruptcy may take three to four months to complete. Add that to the time it takes for a lender to reschedule a previously cancelled foreclosure sale, and the bankruptcy can provide significant extra time in your home.
You may be able to use the extra time to your advantage, either by living rent-free in the home or working out a foreclosure alternative with your lender, such as a loan modification or short sale.
If you are seeking a loan modification, bankruptcy may also assist you in lowering your debt-to-income ratio which many mortgage lenders consider when evaluating loan modifications. Eliminating the amount of money you are paying towards credit card debts and other debts, provides you with more disposable income, and may make your mortgage modification application look better to the lender.
If you have reason to believe that your mortgage is not valid, or is unenforceable, or that the party seeking to collect the mortgage does not own the loan, you may be able to contest the lender’s lien in the bankruptcy court. This is especially useful in non-judicial foreclosure states, where there is no court action needed to foreclose on and sell a home. In these states, a contested action in bankruptcy court may be the only opportunity to challenge the validity of the mortgage.
Unlike Chapter 7, where your debts are wiped out, Chapter 13 requires that you make some payments on certain debts during a three to five year payment plan. In return, you get to keep your property. Chapter 13 bankruptcy has a number of features which can help save your home from foreclosure, including:
To learn more about how Chapter 13 bankruptcy can help you save your home, see Using Chapter 13 to Avoid Foreclosure.