People file for bankruptcy with the intention of getting a “discharge,” or forgiveness of their debts. A bankruptcy discharge wipes out your obligation to pay so that you can start again with a clean financial slate. However, mortgage debt isn’t technically “discharged” in bankruptcy. That’s not to say that bankruptcy can’t help with your mortgage debt – it often can. Let’s take a look at how a mortgage is treated in bankruptcy.
Mortgages And Foreclosure
In order to understand how mortgages are handled in bankruptcy, we need to know how mortgages and foreclosures work. A mortgage loan is the loan you take out to purchase your home. It’s a secured debt, meaning it’s linked to a specific piece of property as “security.” A mortgage loan gives the bank a “lien,” or a legal right to the security. If you can’t make your payments, the bank can take possession of the security as payment for the debt. That’s what’s happening when the bank forecloses on your home.
When the bank forecloses on a home, it then sells that home at auction. Sometimes the home sells for more than you owe. If that’s the case, you’re entitled to the extra. Sometimes, the home sells for less than you owe. The difference between the sale price and the amount of the debt is called the “deficiency.”
Depending on the type of foreclosure proceeding, you may be required to pay the deficiency. California offers two different types of foreclosure proceedings: nonjudicial and judicial. A nonjudicial foreclosure doesn’t require the lender to go to court in order to foreclose. If a home is sold through a nonjudicial foreclosure, the lender does not have the right to collect a deficiency. In other words, you’re off the hook for any difference between the amount you owe and the sale price. A judicial foreclosure is processed through the court system. In general, judicial foreclosures do allow for deficiencies. That means the lender can sue you for the difference between the amount of the debt and the sale price of the home. The vast majority of foreclosures in California are nonjudicial.
In some cases, you may have a second or third mortgage loan taken out against your home. These lenders have junior liens on the home, meaning that they have a claim after the lender that holds your original mortgage is repaid. They get repaid after the lender that holds your original mortgage does. So, if your lender forecloses and the home sells for more than you owe on your primary mortgage, the lender that holds your second mortgage will get the difference. If there’s money left after the second lender is repaid, that will go to the third lender, and so on until all of the debts are paid.
Technically, a junior lienholder can initiate foreclosure proceedings. However, that rarely happens because they would have to pay the original mortgage holder in full before collecting any proceeds from the sale.
When your home is sold through the foreclosure process, the second (and subsequent) lenders lose their lien on the home. That means they lose their claim to ownership of the property. However, they do still hold a debt and can sue you directly for repayment.
Mortgages In Bankruptcy
If you’re struggling to keep up with your mortgage payments, bankruptcy can help stave off foreclosure. Or, bankruptcy can help you walk away from your property and your mortgage debt without any remaining obligations. The way mortgages are treated in bankruptcy depends on which type of bankruptcy you choose to file.
Mortgages In Chapter 7 Bankruptcy
In Chapter 7 bankruptcy, you’ll divide up your assets into exempt and nonexempt piles. Non-exempt property can be sold by the trustee to partially pay creditors. However, that rarely happens. California offers two different sets of exemptions to protect your property, and you can choose based on the type of assets you want to protect. So most filers are completely protected and don’t have to surrender any property at all. Most unsecured debts remaining after this process are discharged, meaning that you are no longer legally required to pay them.
Your mortgage, however, is a secured debt. If you want to walk away from that debt completely, you’ll have to surrender your home. If you surrender your home in bankruptcy, the bank will take possession of it and sell it just like at a foreclosure. However, bankruptcy wipes out your personal liability for the debt. That means you won’t have to pay a deficiency if the home sells for less than you owe.
If you have a second or other junior mortgage, your bankruptcy discharge will wipe out your personal liability for that, too. However, the liens will typically remain, meaning the lienholders retain a right to foreclose if you don’t make payment.
Mortgages In Chapter 13 Bankruptcy
Chapter 13 bankruptcy works differently, and is often a better option for a homeowner who is behind on mortgage payments but wants to keep the house. That’s because in Chapter 13, you can catch up past-due mortgage payments over time.
In Chapter 13 bankruptcy, you’ll give the court a full report of your income and expenses. You’ll work with the court and your bankruptcy attorney to come up with a payment plan based on your earnings and the value of your nonexempt assets. You’ll make payments for 3-5 years, after which many remaining unsecured debts can be discharged. Your payments will go to your secured debts, such as your mortgage and auto loans, first. Whatever is left each month will go to your unsecured creditors.
In order to keep your home in Chapter 13, you’ll need to show the court that you can afford to make your regular payments and also payments for any arrears. If you can make those payments, the bank is required to let you keep the home. As in Chapter 7, the discharge at the end of your bankruptcy process will wipe out your personal liability for the loan. The bank will still be able to foreclose, but it won’t be able to sue you for any deficiency.
If you have a second or other junior mortgage, you may be eligible for “lien stripping.” If your home is “underwater,” meaning it’s worth less than you owe, any junior liens can be stripped away. That means the holder of your second mortgage loses its claim on your home and your second mortgage debt becomes regular unsecured debt. That unsecured debt will be discharged after bankruptcy. If your home is not underwater, you’ll need to continue to make payments on your second mortgage in order to avoid foreclosure.
How much mortgage debt can I wipe out?
In Chapter 7 bankruptcy, there is no limit on the amount of mortgage debt you can wipe out. But, that applies only to personal liability for the debt. Since the lender’s security interest in the property remains, you can only truly wipe out mortgage debt in Chapter 7 if you surrender your home or your home has already been foreclosed on and the lender is pursing a deficiency balance.
Chapter 13 is somewhat more limited. In order to use the Chapter 13 bankruptcy process, you must have less than $1,580,175 in secured debts and less than $526,700 in unsecured debts in order to qualify for Chapter 13 bankruptcy.
What should I do about my mortgage?
As you can see, the treatment of mortgages in bankruptcy can get a little complicated. If you’re struggling with debt and you have a mortgage, contact us today for a free consultation and case evaluation with one of our experienced California bankruptcy attorneys. We can explain your options and what to expect for your mortgage. We can also help you decide on the best course of action for your unique goals and needs.