The biggest assets most people have is their home. The fear of losing a home is one of the things that makes bankruptcy so traumatic. Before the bankruptcy filing, there are the constant calls from creditors, attempts by creditors to get judgments or liens against the property, and for many in the past decade the lack of control as the economy reduced the value of homes.
The reduction in value left many people with homes that were underwater which means the value of the home was less than the mortgages.
Homeowners do have remedies to help them manage this crisis. Some remedies are pre-bankruptcy and some are post-bankruptcy.
Some remedies help to save the some while others help to minimize debt issues and maximize the net proceeds when the house is sold.
Pre-bankruptcy remedies
- Loan Modification: This is a renegotiation of the debt. Some mortgage holders and lien holders may agree to take less money each month if the loan is extended beyond its original length. Debtors should review their finances with a bankruptcy lawyer or with a lawyer knowledgeable in loan modification pros and cons before agreeing to extend the loan.
- Debt Consolidation: Some debtors have multiple loans. Sometimes these loan debts can be consolidated into one loan. The amount that is owed is still the same. The main reason for doing a debt consolidation is because the interest rate may be lower. The interest rate does have to be substantially lower than the rates on the existing loans to make this concept work.
- Short Sales: If a home is underwater, then the second and third mortgages and liens after that first mortgage have no value. It may be possible to sell the home through a private sale and get the latter mortgage holders and lien-holders to waive their interest in the home. This way, the debtor can give clear title to the home. The latter creditors will still have a legal claim to money, but they’ll have to get it from sources other than the home. This remedy can be slightly better for the debtor’s credit record than a foreclosure.
- Direct sale of the home: If a debtor knows that he/she can’t pay the bills and there is equity in the home, it may be wise to sell the home and pay off the creditors instead of not paying the bills and damaging your credit.
Post-bankruptcy remedies
The Automatic Stay: The filing of a Chapter 7 or Chapter 13 bankruptcy operates as an automatic stay. This means all collection efforts by creditors and mortgage holders must immediately stop. The automatic stay does stop foreclosure actions.
To continue forward the mortgage holder must ask the Bankruptcy Court for relief from the automatic stay.
To get relief and continue the foreclosure action, the mortgage holder will have to show that the debtor’s Chapter 13 plan isn’t viable or that their action will not harm other creditors in a Chapter 7 Bankruptcy.
The stay gives the debtor time to breathe and to really figure out what can be done with the home. Foreclosure
Chapter 7 is a process where the debtor liquidates his/her unsecured debts. Secured debts do normally have to be paid. If there is a mortgage, then the home is security for the loan and will likely be sold.
The sale will proceed through a foreclosure action if the mortgage holder gets permission from the court to proceed. Alternatively, it will be sold by the Trustee in Bankruptcy.
Reaffirmation: The debtor also may able to reaffirm the obligations on the home – though he/she will normally have to make arrangements with the mortgage holder to pay the arrears and convince the mortgage holder that he/she can make the monthly payments.
To reaffirm the debt, the debtor has to have an equitable interest in the home. If the home is underwater – the home loans are more than the value of the home, then reaffirmation won’t be allowed.
In many cases, the home is worth more than the loans on the home so reaffirmation is a possibility. Debtors really need to review their finances with a debtor’s attorney to see if reaffirmation is realistic.
Once a Chapter 7 is complete, the debtor can’t use bankruptcy again for years.
Use of Federal Exemptions: Debtors do have state and federal exemptions. These exemptions may help the debtor save the home. Again, the remedy is a reaffirmation. But the exemption can be used to show the debtor does have some equity.
For example, if a home is worth $140,000 and the loans are $145,000 the debtor wouldn’t have any equity. But because the federal exemptions are more than $5,000, the debtor would be allowed to keep the home if he/she reaffirms the debt.
For many debtors, a Chapter 13 bankruptcy is the more common way to try save a home. Chapter 13 requires that the debtor come up with a plan to pay the arrears over a three to five year period and to continue paying the monthly payments. If the debtor can pay the monthly bills plus enough monthly on the arrears, then the debtor will be able to save the home.
For example, if the monthly mortgage is $1,000 a month and the arrears are $6,000 – then the debtor would offer to pay the $1,000 a month plus an extra $100 a month. $100 over 60 months is $6,000. The good news for debtors is they won’t have to pay the interest on the arrears.
Mortgage stripping: Because many homes lost value during the recession, many second and third mortgages have zero value. They thus are essentially unsecured because the collateral, the home, can’t cover the debt.
Chapter 13 allows the debtor to strip these mortgages and just pay the mortgages that have value.
The second and third mortgage holders and any lien holders will get some money but it’s usually just a small percentage on the dollar – depending on what the debtor can really afford.