Foreclosure rates in the U.S. have skyrocketed since the housing market crash. Last year, more than 2.5 million homeowners received foreclosure notices, a 2.5 percent increase over the previous year and more than 23 percent increase over foreclosures in 2008. New York has remained one of the states hardest hit, with Queens New York ranking second only to Kings County as the city with the highest foreclosure rate in the nation. If you’re one of these homeowners, you may be asking yourself what you can do with mortgage loans in bankruptcy.
For some people, foreclosure may be the best way to rid themselves of mortgages they can no longer afford, but for others, foreclosure is not the only option. For those who want to keep their homes but cannot afford it, filing for bankruptcy may be a reasonable solution with less damaging financial consequences than other courses of action, such as sitting at home waiting for the sheriff to show up on your doorstep.
While both foreclosure and bankruptcy will remain on your credit report for seven years, a foreclosure can have a much harsher impact on your ability to secure credit in the future. In comparison, those who file for bankruptcy may begin receiving offers for credit cards within one to two years of completing bankruptcy – because creditors know you’re now debt-free – and you may be eligible for a new mortgage within as little as four years, depending, of course, on your individual circumstances.
Exempting Your Home in Chapter 7 Bankruptcy
What follows is a simplistic analysis of home exemptions in chapter 7 and chapter 13 bankruptcies. Your individual circumstances will definitely play a role in what you ultimately decide to do.
If you want to keep your home and do not have much equity in it, chapter 7 bankruptcy may be your best bet. Under Queens New York law, homeowners who file for chapter 7 are allowed to exempt up to $150,000 in equity in their primary residence under the homestead exemption. (You must, however, generally continue to make mortgage payments if you wish to keep your home in chapter 7 bankruptcy.)
Equity is the difference between what the home is worth and what is owed on the home. For example, if you own a home worth $350,000, but you still owe $300,000, then you have $50,000 in equity in the home, putting you well within the homestead exemption.
However, if you have more equity in the house than the exemption amount, chapter 7 may not be the right fit for you. In a chapter 7 bankruptcy, the court will assign a trustee to collect any non-exempt property you own to sell it to repay some of your debts. This includes any equity in your house above the exemption amount.
For example, if your house is worth $350,000 and you owe the bank $100,000, then you have $250,000 in equity in the home – well above the exemption amount. In this example, the bankruptcy trustee can force a sale of your home and take any amount from the sale over $150,000 to repay your creditors.
In cases such as this, the better option may be to file for chapter 13 bankruptcy.
Catching Up on Your Mortgage in Chapter 13 Bankruptcy
Chapter 13 bankruptcy is another way you may be able to keep your home out of foreclosure. In chapter 13 bankruptcy, you will work with the bankruptcy court and trustee to create a payment plan to pay off a portion of your secured debts within three to five years. This repayment plan can include missed mortgage payments, giving you an opportunity to make up late payments and get current on your mortgage.
The catch about chapter 13 bankruptcy, however, is that it only works if you have enough disposable income to make the payments every month, on time, throughout the entire three to five years of your repayment plan (this is why chapter 13 is also known as “wage-earners” bankruptcy, though why that is remains somewhat a mystery – it’s not like those who file for chapter 7 don’t have jobs). If you can do this, then unsecured debt, like credit cards and medical bills, will be discharged after you have successfully completed your chapter 13 repayment plan.
If you are unable to keep up with the repayment plan, then you may have the option of converting your bankruptcy to a chapter 7 filing; however, the conversion will not save your house from foreclosure if you own more than $150,000 in equity in the home, or if you cannot otherwise make your mortgage payments. If you do not convert to chapter 7 and do not complete the repayment plan, including keeping current on your mortgage, then the lender can take steps to foreclose on your house.
Stripping a Second Mortgage
If you are like thousands of other homeowners who owe more on their mortgage than the home is worth (you’re “underwater”), you may be able to eliminate, or “strip,” a second mortgage through chapter 13 bankruptcy.
In some cases, you can strip your second mortgage so long as it is wholly unsecured. This means that the value of your house must be equal to or less than the amount owed on your first mortgage. For example, if you owe $200,000 on your first mortgage and $50,000 on your second mortgage, but your home is valued at $198,000, there is not enough value in your house to secure the second mortgage. As a result, you are eligible to strip the second mortgage off what you owe.
A second or subsequent lien on your property can only be stripped once you have completed the chapter 13 repayment plan. This means making all of the payments for the entire repayment period, which includes staying current on your first mortgage.
The Next Step: Contact a Bankruptcy Attorney
If you have received a home foreclosure notice or have fallen behind on your mortgage payments, talk to a bankruptcy lawyer before you do anything else. Whether you want to keep your home or are ready to let it go, learn about selecting a bankruptcy attorney who can explain your legal options and help you get back on track.