Sometimes, circumstances change, like an accident, a job loss, a medical problem, or a divorce that causes you to fall behind on your mortgage payments.
When that happens, it can be a terrifying feeling hounded by phone calls and notices that you’re past due. Foreclosure proceedings typically begin because you have fallen behind on your mortgage payments.
However, foreclosure isn’t the end of the road.
The lender must notify you about foreclosure, and the process can take some time, allowing you to use alternate measures like renegotiating the loan, crafting a deed in lieu of foreclosure, or organizing a short sale.
In extreme cases, filing for bankruptcy can help avoid a potential foreclosure, at least temporarily.
How Filing for Bankruptcy Works
Bankruptcy and foreclosure are two things no homeowner wants to experience.
But life happens, and you might be forced to face the reality of both situations.
If it feels like your debts are mounting and your bills are drowning you, bankruptcy offers a solution.
When you file for bankruptcy, the court typically issues an automatic stay (provided you’ve not had a prior bankruptcy case dismissed within the previous year). An automatic stay is an order that stops creditors from trying to collect debts. The order includes a clause that a mortgage holder ceases foreclosure activities.
If your lender has already scheduled your home to be sold at a public auction, the sale will be legally postponed for 3-4 months unless the creditor effectively brings a motion to lift the stay.
But regardless of whether the motion to lift the stay is brought successfully, the sale will probably be postponed, which can buy you time to make other plans.
The automatic stay doesn’t stop the clock on the notice mandated in many states before the lender can make the foreclosure sale. After the calendar months have passed for notice, your lender can file a motion to lift the stay regardless of your bankruptcy situation.
Types of Bankruptcy
There are 2 common types of bankruptcy, and each has distinct benefits and drawbacks when it comes to working through a foreclosure.
Contrary to popular misconception, bankruptcy may not eliminate your financial responsibility to your lender or protect your credit score.
It can, however, halt the foreclosure process until the court reaches a decision regarding the validity of your bankruptcy.
Chapter 13 Bankruptcy
Chapter 13 may let you keep your home.
While it won’t eliminate your debts, it will create a plan that re-organizes them in a way that may be more manageable. (United States Courts)
Chapter 13 bankruptcy comes with a detailed payment plan that will span over 3-5 years. (Forbes) You can pay off the late mortgage payments over the length of the repayment plan, provided you continue to meet your current mortgage payments as well. If you make timely payments under your debt repayment plan, you can avoid foreclosure.
But sometimes, you’re late on mortgage payments because you have multiple mortgages. It may be that the value of your house has dropped since the most recent economic crisis, and your second or third mortgages are no longer fully secured by the property’s value.
If there’s not enough equity to secure one or more junior mortgages, you can employ lien stripping to save your home. Lien stripping means you can ask the Chapter 13 bankruptcy court to strip the junior mortgages that aren’t secured and re-badge them as unsecured debt.
Unsecured loans will be stricken from the record, but the initial debt to your lender will remain. Unsecured debts have the lowest priority in bankruptcy and may not be paid back fully or at all.
Chapter 7 Bankruptcy
Immediately upon filing a Chapter 7 bankruptcy, the automatic stay will temporarily stop a foreclosure sale. As no payments are made in a Chapter 7 case, you need to negotiate with a foreclosing creditor outside of your bankruptcy case to resolve issues related to the debt on the home.
Chapter 7 liquidates all assets (including your home) to pay your creditors. (Experian) The fact that it’s faster and doesn’t involve a repayment plan makes it the most common type of bankruptcy filed in the United States
Chapter 7 bankruptcy can’t and will not save your home – you’ll still go through a foreclosure.
The only difference is that your lender would not be able to pursue you for a deficiency judgment if this type of bankruptcy is granted.
If your goal is to save your home, only chapter 13 will offer you the necessary tools.
Chapter 7 bankruptcy will cancel any debt secured by your home, including home equity loans and the debt of junior mortgages. (Debt.org) You’ll get a fresh start in the form of a discharge order within 3-4 months of filing your petition.
Who Is This Option Good/Not Good For?
Chapter 13 is the best strategy for homeowners who are hopelessly behind on their mortgage but whose financial hardships are only temporary.
Filing for Chapter 7 isn’t a good choice if you don’t plan on giving up your home.
How Does Filing for Bankruptcy Affect My Credit Score?
You may be legitimately concerned about the effect of bankruptcy on your credit score.
A Chapter 7 bankruptcy can remain on your credit report for 10 years, and 7 years for a Chapter 13 bankruptcy. (TransUnion)
However, foreclosure not only damages your credit score for years which can be harmful in future efforts to buy a house, but it also does not get rid of other debt.
When Should I File for Bankruptcy?
In many cases, the biggest problem when trying to stop a foreclosure is that homeowners wait too long. Many wait until the eve of the actual foreclosure sale to give bankruptcy a chance. Waiting until the last minute can leave you in a tight spot.
It can be tricky to get an available attorney who can take time to prepare and process all that’s necessary to get the case filed in time to prevent the sale. This mad rush is obviously not the best situation to file for bankruptcy.
If you’re considering filing for bankruptcy or need help figuring out how to access bankruptcy protections to protect your home from foreclosure, get in touch with an attorney early.
DIY Vs. Seeking Professional Assistance
The bankruptcy and foreclosure process are very technical and can be difficult to navigate.
Hiring a professional can make the whole process much easier and get you a better result. Since they’re familiar with the courts, including judges and opposing attorneys, these relationships allow attorneys to negotiate a better deal.
"Debt.org." n.d. What Is Chapter 7 Bankruptcy? 13 11 2022. <https://www.debt.org/bankruptcy/chapter-7/>.
"Experian." 2 12 2019. What Is Chapter 7 Bankruptcy? <https://www.experian.com/blogs/ask-experian/what-is-chapter-7-bankruptcy/>.
"Forbes." 29 7 2022. Chapter 13 Bankruptcy: What Is It, and Would It Help You? <https://www.forbes.com/advisor/debt-relief/chp-13-bankruptcy/>.
"TransUnion." 18 5 2021. How Long Does Bankruptcy Stay On Your Credit Report? <https://www.transunion.com/blog/credit-advice/how-long-does-bankruptcy-stay-on-credit-report>.
"United States Courts." n.d. Chapter 13 - Bankruptcy Basics. 13 11 2022. <https://www.uscourts.gov/services-forms/bankruptcy/bankruptcy-basics/chapter-13-bankruptcy-basics>.