One of the most recommended but least desirable options to save a home from foreclosure is filing bankruptcy. It seems like a solid legal defense against eviction and a way to get more time to work out another solution, but few homeowners really want to damage their credit for nearly a decade just for another chance to save their home, especially when other options may require decent credit. But filing bankruptcy should be considered a last resort by most homeowners in case nothing else works out in time.
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In any case, filing bankruptcy and including the mortgage loan in the petition will temporarily stop any foreclosure proceedings or other collection efforts by the lender. The federal order for relief (also known as the automatic stay) will go into effect immediately, which will prohibit any creditors from pursing collection activities for as long as the stay is in place. This means that the bank can not move ahead with its lawsuit against the borrowers, nor have the house sold at a county sheriff sale.
But where the house goes from there depends on whether the owners file Chapter 7 or Chapter 13 bankruptcy. There are big differences between the two, and state exemptions and rules may determine which one filers best qualify for and what property they would get to keep under various circumstances. The best idea is probably to consult with a personal bankruptcy lawyer before moving ahead with either filing, although it is quite possible, easy, and cheap for homeowners who understand the process to file bankruptcy on their own using a book or online examples.
A Chapter 7 will allow debtors to discharge much of their unsecured debts and secured debts, as long as the creditors have access to the collateral for which the secured loan was guaranteed. That means that homeowners can discharge a mortgage under this type of filing, but the bank will get to keep the house as satisfaction of the debt. Homeowners will also not have to worry about a deficiency judgment (as rare as they are to begin with), as the house will be considered the best the bank can expect and any remaining balance on the mortgage will be discharged. If the borrowers owe $150,000 but the house has declined in value to $100,000, the bank can not try and sue for that difference later on -- it is simply discharged.
With a Chapter 13, borrowers will enter into a payment plan in order to get caught up on the debts that they have fallen behind. Currently, bankruptcy judges do not have the authority to lower mortgage balances or negotiate the regular payment terms, so homeowners would have to pay back the total amount they have fallen behind as well as keep up on their current regular monthly mortgage payment. For many homeowners, this can be prohibitively expensive; although, if they are able to make it through the 3-5 year bankruptcy plan, they will save the home and be current on the loan. However, it should be kept in mind that it they fall behind on the bankruptcy plan, the bank will quickly have the automatic stay lifted and put the house back into foreclosure.
Homeowners need to consider the pros and cons of filing bankruptcy as a solution to foreclosure. On the one hand, collection actions are halted immediately, the house can not be auctioned off, the mortgage can be discharged with no possibility of a deficiency judgment, and it is one more chance to get caught up. On the other hand, borrowers will not be able to keep their home in a Chapter 7 discharge, and the payment plan may be too expensive in a Chapter 13, and neither filing will stop foreclosure entirely as it only puts the process on hold while debtors use the federal courts in defense against creditors. Although bankruptcy should be a tool every foreclosure victim may have to rely on, it should only be used in the most appropriate circumstances.
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