If you are facing foreclosure, bankruptcy might help. In many cases, filing for Chapter 7 bankruptcy can delay the foreclosure by a matter of months. Or if you want to save your home, filing for Chapter 13 bankruptcy might be the answer.
What Is Foreclosure?
Typically, a foreclosure begins after a homeowner falls behind on mortgage payments. The lender must follow the process outlined in state law before selling the home at auction. The lender applies the sales proceeds toward the mortgage balance. Whether the lender will be able to collect any remaining balance from the borrower—called a deficiency balance—will again depend on the laws of the state. The process involves numerous steps, including notification to the homeowner.
Fortunately, the bankruptcy process won't happen overnight. Usually, a lender won't begin the foreclosure process until you've missed several payments, often three or four. That gives you time to try some alternate measures, such as loan forbearance, a short sale, or a deed in lieu of foreclosure. But if you've already tried and failed with these measures, it makes sense to consider whether bankruptcy can help you avoid foreclosure, or at least buy you a little time. Here are some ways that filing for bankruptcy can help you.
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The Automatic Stay: Delaying Foreclosure
When you file either a Chapter 13 or Chapter 7 bankruptcy, the court automatically issues an order (called the order for relief) that includes a wonderful thing known as the "automatic stay." The automatic stay directs your creditors to cease their collection activities immediately.
If your lender had scheduled your home for a foreclosure sale, and you file for Chapter 7 bankruptcy, the sale will be legally postponed while the bankruptcy is pending—typically three to four months. However, the lender can ask the bankruptcy court for permission to proceed with the sale by filing a "motion to lift the automatic stay." If successful, you won’t get the full three to four months.
But, even so, it takes time for the motion to be filed and heard, so the bankruptcy will typically postpone the sale by at least two months, or even more if the lender is slow in pursuing the motion to lift the automatic stay.
How Chapter 13 Bankruptcy Can Help
Many people want to remain in their home and will do whatever they can to stay in their home for the indefinite future. If that describes you, and you're behind on your mortgage payments with no feasible way to get current before foreclosure, the only way to keep your home is to file a Chapter 13 bankruptcy.
How Chapter 13 Works. Chapter 13 bankruptcy lets you pay off the "arrearage" (late unpaid payments) over the length of a Chapter 13 repayment plan you propose—five years in most cases. But, you'll need enough income to meet your current mortgage payment in addition to paying off the arrearage. Assuming you make all the required payments up to the end of the repayment plan, you'll avoid foreclosure and keep your home.
2nd and 3rd Mortgage Payments. Chapter 13 bankruptcy might also help you eliminate the payments on your second or third mortgage. Here’s how it works. If your first mortgage is secured by the entire value of your home (which is possible if the home has dropped in value), you might no longer have any equity with which to secure the later mortgages. That allows the Chapter 13 court to "strip off" the second and third mortgages and recategorize them as unsecured debt—which, under Chapter 13 bankruptcy, takes last priority and often does not have to be paid back at all. As home equity rises, this approach is used less frequently.
Nonexempt Equity. The great recession hit home equity hard, and it was unusual for a bankruptcy filer to have much, if any, equity in a home. Since that time, home values have continued to climb. Now a filer must carefully consider the ability to fully protect equity with the homestead exemption allowed by filer’s state. If the homestead exemption isn’t sufficient, to keep a house, a filer will have to pay the value of the nonexempt property in the repayment plan, too.
Connecticut Homestead Exemption Amount
The homestead exemption protects the equity of the homeowner's that is eligible homestead property. This is the value of the home less any mortgage balance. The basic amount of equity protected in Connecticut is up to $75,000, with debts related to hospital bills protected up to $125,000.
Related: 5 Steps to Prevent Mortgage Default When You Lose Your Job
Further: Chapter 7 vs 13 Which One Makes Sense For You?
If you own a home and you're current on your mortgage payments, you'll probably be able to keep it whether you file a Chapter 7 or a Chapter 13 bankruptcy. Read on to learn about the requirements under each chapter.
Keeping Your Home in Chapter 7 Bankruptcy
Chapter 7 cases are often more attractive because they’re quicker, easier, and get you on the road to financial stability sooner because you don’t pay into a three- to five-year repayment plan. You’ll be able to keep your house as long as you meet the following criteria:
You’re current on your house payments.
You can protect all of your home equity with a bankruptcy exemption.
You’ll be able to continue making your payments in the future.
Chapter 7 bankruptcy does have some limits as a tool for managing mortgage debt, however. It won’t help you catch up past due payments, and it might be difficult to protect the house if you have a lot of equity in it (the bankruptcy trustee will sell it and use the nonexempt equity to pay other creditors, such as back taxes, credit card balances and personal loans).
Chapter 13 bankruptcy can be a better choice to address both those issues so you can keep the home. Chapter 13 might also give you the opportunity to get rid of second or third mortgages.
Chapter 13 Bankruptcy and Past-Due Mortgage Payments
If you’re behind on your mortgage payments and you want to keep the house, Chapter 13 bankruptcy provides a mechanism for helping you get caught up—something that Chapter 7 bankruptcy cannot do. In Chapter 13 bankruptcy, you propose a payment plan that will allow you to pay your creditors over three to five years. You can treat your mortgage arrearage as a separate debt and add it to your payment plan.
Using the Chapter 13 plan to catch up your arrearages will only work if you have the income to make both your regular monthly mortgage payment and your plan payment while you’re in bankruptcy. Your mortgage creditor can’t take any action to foreclose the mortgage as long as you’re paying your house and plan payments on time and otherwise keeping to the terms of your mortgage, like ensuring that you have homeowners insurance in place.
Protecting Your Home Equity with a Chapter 13 Bankruptcy
In a bankruptcy case, you can often protect an asset by claiming a bankruptcy exemption for it. Each state has its own list of exemptions. The types of property and the amount of value you can protect vary widely. Only a few states allow you to keep all of your home equity when you file bankruptcy. In most states, the maximum you can exempt is much lower.
In a Chapter 7 case, if the exemption isn’t enough to cover the entire amount of your equity, the court-appointed trustee could sell it and use the proceeds above your exemption amount to pay off some of your unsecured debt, like credit cards and medical bills.
Chapter 13 bankruptcy works differently. You won’t be forced to give up any property. Instead, you’ll pay out the nonexempt portion of the equity over the course of your plan. Of course, if you have significant nonexempt equity, this could get expensive. You’ll have to demonstrate that you have enough income to pay all amounts required in your plan.
Example. You have $50,000 in equity in your house but the maximum amount you can exempt is $30,000. You'll have to structure your Chapter 13 payment plan so that your unsecured creditors will receive at least $20,000 over the life of the plan. That amount is in addition to any other debts your plan payment must cover, like mortgage arrearages, car payments, past due child support, or back taxes.
Using Chapter 13 Bankruptcy to Remove Junior Liens
As mentioned above, if you have a second or other junior lien on your homestead, you might be able to get rid of it through a process called “lien stripping.” This is only available in a Chapter 13 case, and ONLY when your property is worth less than the balance of the primary loan.
To strip the lien, you'll have to file a motion in the bankruptcy court and present evidence on the value of the property and the mortgage loan balances. If the court voids the junior lien, the debt you owe to that creditor will be treated in the Chapter 13 case as if it were unsecured. Any remaining balance will get wiped out with other qualifying unsecured debt at the end of the case.