The mortgage company promises of more time have run out. Foreclosure notices are piling up and a foreclosure sale is nearing. Where will your family go if you lose the house? You are not alone. Many have faced similar worries and have found help from bankruptcy.
If you continue to have regular income - even if one spouse lost a job and what is left does not pay the bills - Chapter 13 of the U.S. Bankruptcy Code may offer the solution. Also known as a reorganization or wage-earner plan, Chapter 13 may allow a homeowner to stop a bank foreclosure and ultimately keep a home after the bankruptcy.
Chapter 13 basics
After filing a petition for Chapter 13 bankruptcy, the court orders an automatic stay that requires all creditors to cease collection efforts during the bankruptcy. The stay also stops collection lawsuits and foreclosures in process (but not those already completed, so timing is important).
In the Chapter 13 bankruptcy, a monthly payment is made as part of a court-approved repayment plan. These payments are then disbursed to the various creditors. This plan lasts three to five years, after which most remaining debts are discharged (extinguished).
The affect on a mortgage
If you want to keep the mortgage on the home and continue to own the residence beyond the bankruptcy, you must do two things during the Chapter 13 bankruptcy:
- Make up past-due mortgage payments during the repayment-plan period
- Make all mortgage payments on time that come due during the bankruptcy
Underwater mortgages and lien stripping
Following the recent recession, underwater mortgages have become common. This means that the value of the home has dropped below the balance due on the mortgage.
When this is the case, all of the equity in the home is dedicated to securing that mortgage. For example, a home may have been worth $300,000 at the time a mortgage was signed. After the recession, because of the loss in value in many homes, the value of the home could have dropped to $200,000. There could easily still be $250,000 due on the mortgage, making it underwater. All of the $200,000 in equity goes to secure at least that much of the mortgage debt, leaving no excess equity above the amount of the mortgage.
In Chapter 13, when there is no excess equity after the first mortgage is secured, a second mortgage that may have been taken out on top of the original mortgage and that was secured by excess equity in the home at that time, is no longer secured at all because there is not even enough equity in the home to fully secure the original mortgage.
In this situation, the debtor can ask the court to strip off the second mortgage (or line of credit or other type of lien on the home) that is now, in essence, an unsecured debt. Stripping a mortgage means that it is extinguished.
If there is any equity left to secure even a small portion of the junior lien, it normally cannot be stripped.
Little room for bank creativity
In one recent U.S. Bankruptcy Court case, a bank tried to preserve its junior mortgage and prevent it from being stripped by waiving part of the bank's claim under the first mortgage so that its balance would drop below the home's value. In theory, this would leave some equity to secure part of the second mortgage and thus prevent it from being stripped.
The creditor tried to do this by waiving its right to interest and costs that was part of the amount of money due under the first mortgage and to which the bank had a "right to payment." The U.S. bankruptcy judge in that case called the bank out, not allowing it to "manipulate its claim" in the senior mortgage to try to prevent stripping of the junior mortgage.
Issues related to saving a home, stopping foreclosure and stripping junior liens are often very complicated. If a job loss, illness or injury makes in near impossible to make the mortgage payments, speak with an experienced bankruptcy lawyer about potential legal options.