Can You File for Bankruptcy to Avoid Foreclosure?
Reviewed by Carina Jenkins, J.D.
Your home is likely the biggest investment you have, so falling behind on mortgage payments and facing foreclosure can be scary. If you're experiencing this now or are worried it could become an issue in the future, knowing all your options can increase the likelihood that you will keep your home.
One of those options is filing for bankruptcy. Here’s what you need to know.
For many homeowners, filing for bankruptcy is an option to stop or prevent foreclosure on their property. This can be true for both Chapter 7 and Chapter 13 bankruptcy filings, but the method varies between the two. This should always be considered a last resort, since the impact of bankruptcy can affect you and your family for several years.
Since bankruptcy erases or consolidates most debt, this can offer relief when you're struggling to make ends meet, and the mortgage is at risk of going into default. Although this won't eliminate what you owe on your home, you may find it easier to make your payments once some of your other obligations are reduced.
The exact mechanics of this option depend on the type of bankruptcy selected, but it generally begins with an automatic stay. This freezes all credit accounts, preventing you from adding additional debt but also preventing creditors from taking further action until the filing is completed. Any ongoing or impending foreclosure is halted for a period of time determined by your bankruptcy type. You may not get an automatic stay if you have previously filed for bankruptcy. These policies exist to prevent people from manipulating debts or taking advantage of the stay by filing and dismissing bankruptcy cases.
Chapter 13 is more of a consolidation plan in which all eligible debts are considered, and a payment plan is created by the court to pay any arrears over a period of three to five years. If your mortgage is in arrears, this option can buy you time to catch up on payments and bring the account current. It's important to note that the automatic stay remains in effect until the end of the established payment period. If the mortgage is still behind at this time, the automatic stay is lifted, and the lender is free to continue with foreclosure proceedings.
Chapter 7 bankruptcy involves liquidation of your non-exempt assets to reduce your debts and is only allowed if your monthly income exceeds your state's median family income. Exempt assets and equity limits are determined by your state. Once all eligible assets have been sold and the proceeds distributed to debtors, any remaining balances are discharged. To protect your home, it's best to bring the mortgage current or negotiate a loan modification soon after you file to prevent the lender from petitioning the court to take possession of your home. The automatic stay is lifted once the liquidation and discharge process is complete, which usually takes about three to four months.
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Filing for Chapter 13 bankruptcy is often the best option for preventing foreclosure because there's an extended period with the automatic stay in place. This buys the homeowner a few years to come up with a plan for back payments.
Chapter 7 could be an option too, but unless the mortgage is brought current soon after filing, the lender has the right to petition the court to sell the home to recover what they're owed. The viability of this option depends on your state's laws and often comes down to the amount of equity you have in your home.
In some situations, bankruptcy does stop the foreclosure process, but it should always be viewed as a last resort. It may sound tempting to free yourself of additional debt while trying to save your home, but the damage to your credit may limit your future options if a similar situation arises. In general, here are some pros and cons that can help you decide:
- Bankruptcy could offer a clean financial slate.
- Chapter 13 can give you time to bring your mortgage current.
- Eliminating back monthly payments can make it easier to keep up with your mortgage.
- Courts can eliminate excessive interest charges on other debts, offering savings that can be stashed for mortgage payments.
- Bankruptcies have long-term ramifications on your credit.
- It's still possible to lose your home with a Chapter 7 filing.
- Some debts are not eligible for discharge, which would reduce the financial impact once the bankruptcy is complete.
- Your lowered credit may make it difficult to seek some mortgage options in the future, such as refinancing.
- Cosigners are not included in the automatic stay.
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