A major concern for most homeowners who are contemplating Chapter 7 or Chapter 13 bankruptcy is how the bankruptcy will affect their mortgage. The good news is that your mortgage company cannot raise your interest rate or change other terms of your loan to punish you for filing bankruptcy. The bad news is that some homeowners filing for Chapter 7 bankruptcy will lose their home. In Chapter 13 bankruptcy, you can keep your home and continue with your current mortgage.
Chapter 7 Bankruptcy and Your Mortgage
If you file (and qualify) for Chapter 7 bankruptcy and your home is exempt, you can continue to make your mortgage payments if you want to keep your home. Although the bankruptcy will discharge your personal liability for the home loan at the end of the case, the lender’s security interest in the property remains in force. So, if you don’t make your payments, the lender can foreclose.
If you are behind in your mortgage payments and want to keep your home, you’ll have to catch up in order to keep your home. Unlike Chapter 13 bankruptcy, Chapter 7 does not provide a method for you to pay an arrearage through the bankruptcy. To learn more how Chapter 7 bankruptcy affects a home in foreclosure, see Chapter 7 Bankruptcy and Foreclosure.
Is Your Home Exempt?
All of this may be moot if a significant portion of your home equity is not covered by a bankruptcy exemption. In Chapter 7 bankruptcy, most or all of your debts are discharged. In exchange, the trustee is entitled to sell your nonexempt property and use the proceeds to pay your unsecured creditor. That means that if your home has a significant amount of nonexempt equity, the trustee will sell it. To learn if your home has nonexempt equity, see Chapter 7 Homestead Exemption.
Chapter 13 Bankruptcy and Your Mortgage
Chapter 13 bankrupcy does not affect your home mortgage. You continue to make your mortgage payments during and after the bankruptcy.
If you are behind in mortgage payments, you can pay off the arrears through your Chapter 13 repayment plan (which lasts three to five years). As long as you make your current mortgage payments and your plan payments, the lender cannot foreclose. This effectively gives you more time to make up missed payments. To learn more, see Using Chapter 13 Bankruptcy to Avoid Foreclosure.
In some cases, you can get rid of second or third mortgages on your home. This is called “lien stripping.” Here’s how it works. If you don’t have enough equity in your home to secure the second or more junior mortgages, then the bankruptcy court can “strip” the liens securing the mortgages and reclassify the debt as unsecured. This debt then gets paid off through your repayment plan. Most Chapter 13 filers pay only a portion of their unsecured debt through their plan. For more details on lien stripping, seeHow to Strip a Second Mortgage or HELOC in Chapter 13.
Modifying Mortgages: Cram Downs
In some instances, you can modify a mortgage in Chapter 13 bankruptcy so that the new principal equals the actual value of your home. For example, if your mortgage is $500,000 but the property value has declined to $300,000, you could modify the mortgage amount to $300,000. This is called a cram down (and can be used for other secured property too, like car loans).
While this sounds wonderful, it’s not available for a mortgage secured by your residence (the home you live in). It’s only available for these types of mortgages:
- Loans obtained to purchase a multiunit building.
- Loans obtained to purchase other buildings or lots that are not part of your residence (e.g. farmland).
- Loans obtained to purchase a mobile home you live in that is personal property.
- Loans not secured solely by your residence (that is, some other property serves as security for the loan).
And the final kicker: If you are able to cram down (modify) the mortgage to the actual value of the property, you have to pay off the entire new mortgage amount through your Chapter 13 repayment plan. This gives you three to five years to pay it off (depending on how long your plan is) — which is untenable for most people.
(To learn more, see How Cramdowns Work in Chapter 13 Bankruptcy.)
Getting Your Lender to Modify Your Home Loan
You can always try to get the lender to modify your home loan so that the payments are more affordable. To learn more about the new government programs designed to encourage home loan modification, see the articles in Nolo’s Foreclosure area. Be sure to check out our Foreclosure & Bankruptcy area too.