For homeowners coping with financial problems and missed mortgage payments, the notion of claiming bankruptcy might seem like a last resort to be avoided at all costs. But in some cases, bankruptcy might constitute the best way to stop the foreclosure process and prevent permanently losing your home. Once a bankruptcy petition is filed, lenders must stop their debt collection efforts and cease foreclosing on your home unless the mortgage company seeks and obtains special permission to proceed called Relief from Automatic Stay.
How Each Bankruptcy Type Affects a Home
When you are faced with the loss of your home and considering bankruptcy as an option, the first decision to make is which type of bankruptcy will work best for you. The two kinds of bankruptcy that may offer strategies for stopping foreclosure are known as Chapter 7 or Chapter 13. If you file a Chapter 7, it will slow down the foreclosure process but also may require you to liquidate any assets that cannot be protected by exemptions for specific types of property up to a certain value. Chapter 7 provides borrowers with a method to wipe away most forms of unsecured debts like credit card balances and medical bills. This approach might free up enough money each month to catch up on the mortgage and save your house.
Chapter 13 bankruptcy is the most common way for people to improve their financial condition and keep their home especially if the home has substantial equity. This option creates some time – typically from three to five years – for borrowers to turn things around and fix their finances by making monthly payments toward arrearages on secured obligations. A monthly payment schedule will be established based on the borrower’s income, assets, and outstanding debt. These payments are made to the bankruptcy trustee who sends the payments to creditors.
Secured debt, such as your mortgage or car payment gets paid down first which is followed by unsecured priority debt like overdue income taxes, child support, alimony, and certain other obligations. Both the arrearages on secured debt and priority unsecured debt must be repaid in full through the payment plan. Ordinary unsecured debts like credit cards or medical bills may need to be paid back to some extent through your plan depending on your income level but some or all of these debts may be discharged upon successful completion of your Chapter 13 plan. By simply sticking to the schedule established by your Chapter 13 repayment plan and making the payments, the borrower will emerge from bankruptcy and retain ownership of the individual’s home.
Unfortunately, as a sign of the times, many people are in a home that is now worth much less than it was just a few years ago. This is a problem that bankruptcy proceedings cannot rectify. The law does not allow a bankruptcy trustee or bankruptcy court to adjust the principle owed on the mortgage debt down to the present market value of a home. The bankruptcy court also will not extend the terms of a loan or lower interest rates.
Bankruptcy Advantage for Second Mortgages
In the case of a second mortgage, Chapter 13 provides an additional advantage to borrowers because Chapter 13 can eliminate the second mortgage under certain circumstances. When the home’s value falls below the balance of the first mortgage, the judge may choose to wipe away a second mortgage like a home equity line because there is no available equity to which the lien can attach. This relegates the second mortgage to the status of an unsecured debt subject to discharge.
As an example, a financially strapped homeowner might owe a first mortgage amount of $300,000 and owe another $50,000 on a home equity credit line. If the market value of the house dips under $300,000, a bankruptcy judge could declare the equity credit line as unsecured debt. That puts it in the same category as the other unsecured debts to be paid off at pennies on the dollar or sometimes discharged in Chapter 7.
Despite these advantages to filing bankruptcy, naturally, there are some disadvantages to consider before taking this step. Whatever type of bankruptcy you decide to claim, your credit score will suffer a blow for some period of time. Most industry reports show that scores drop around 240 points after bankruptcy and remain on credit reports for years after the discharge.
For millions of homeowners who have faced the loss of their homes in recent years, bankruptcy has provided a viable way to stave off foreclosure. While it’s not an easy decision to make, it does show that financial recovery is possible. If you have questions about bankruptcy and foreclosure, you may want to talk with a Florida bankruptcy lawyer to learn more about whether bankruptcy might provide a way to save your home.
Howard Iken is a Tampa Bankruptcy Attorney that helps Florida citizens seek protection from creditors.