Monday, June 6, 2011

How Does Bankruptcy Stop Foreclosure?

Many people are aware that filing bankruptcy can stop a foreclosure, but how exactly does it work? It's important to know that if you are facing foreclosure, bankruptcy can stop it, but it's not always a permanent fix, and there are different powers in different types of bankruptcy.

First, the Automatic Stay

Once any type of bankruptcy is filed, an automatic stay provision goes into effect. This provision is a protection granted by the bankruptcy court that bars any type of collection effort by any of your creditors. This includes a foreclosure action as well as car repossession, wage garnishment or even creditor phone calls.

This protection however, is not permanent, and your creditors may file a motion to "lift" the stay so they can go on with their effort. If the court grants the motion to lift the stay, a foreclosure may proceed. If the motion is not granted, then your lender has to stop the foreclosure action until your bankruptcy case is processed, which will typically take three to five months.

You Have to Decide What to Do With Your House While Your Case is Pending
Now that the foreclosure is temporarily halted, you'll need to figure out; 1. Whether to keep your house or let it go, 2. How to avoid a deficiency judgement if you choose to let the house go or, 3. How to keep your house if you choose to.

1. Should You Save the House?
While you obviously are attached to the house (you probably wouldn't be reading this if you weren't) it may be a good idea to think about whether you can really afford it or not. If you are one of the many Americans who got into a sub-prime loan and bought "more house" than you can really afford, it may be best to walk away while you have the option.

You need to determine if your income justifies owning the house. The FTC generally recommends that you housing payment not exceed 30% of your gross monthly income. For example, if you earn $5,000 per month, your mortgage payment should not exceed $1,500. If your mortgage payment-to-income ratio is much higher than 30%, it may be wise to say goodbye to that house.

2. Do you need protection from a deficiency judgement?
If you find that you just bought too much house and you elect to let it go, then you'll need to determine if you may be held liable for any deficiency. A deficiency occurs when the house is sold for less than you owe on the mortgage note. Some states have laws against deficiency judgements, but most do not.

If your state does not protect you, then your bankruptcy will. Alternatively, you may be able to work out an agreement with your lender to promise to forgive that debt. This could pose another problem though, as the IRS will tax that "forgiven" debt as income. If that happens, even a bankruptcy can't discharge that.

3. How can you save the house for good?
So you want to save the house for good. A chapter 13 bankruptcy is going to be the best way to do that. Beyond the automatic stay, chapter 13 bankruptcy will allow you to repay your past due mortgage debt over the three to five year payment plan.

To keep the house in a chapter 7, you'd have to come up with that money up front immediately to keep the house out of foreclosure. That's not an easy thing for most people to do.

If You Choose Chapter 13 Bankruptcy
If you elect to get into a chapter 13 bankruptcy and save your house, you will also be able to get a lot of your other debts discharged, making your mortgage payment a little more manageable.

Depending on your income, the plan will last for either three or five years, during which time you must make a monthly payment to the bankruptcy trustee who will then disburse payments amongst your creditors as outlined by your chapter 13 plan. If your financial circumstances change, such as a job loss or divorce, and you cannot make the payment, then you have to promptly notify the trustee to see if the plan can be modified, otherwise your case will be dismissed.

Most people who get into a chapter 13 will wind up getting a large portion of their unsecured debt (credit cards, personal loans, medical debts) discharged upon completion of the payment plan, relieving them of a substantial amount of debt.

Learn More
See the following pages to learn more about chapter 13 and foreclosure laws.
Modifying a Home Loan in Chapter 13
Your Options When Facing Foreclosure
Nolo's Book: The Foreclosure Survival Guide

2 comments:

  1. Can the bankruptcy court make your lender modify your loan?

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  2. There is no law granting courts the power to force a loan modification. However, lenders may be more willing to negotiate modified loan terms while you're in bankruptcy simply because if they don't, they know that any unsecured portion of the loan will be discharged, and they will be "out" that money. This is something that your lawyer might be able to accomplish for you.

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