The Effect of Bankruptcy on Foreclosure

Bankruptcy and foreclosure.

Bankruptcy can be used as a last-ditch effort for a homeowner to slow foreclosure proceedings on his property. However, the effect of declaring bankruptcy when in foreclosure on a property is often short-term. Depending on the type of bankruptcy filed be a home owner, the short-term and long-term effects can vary greatly.

Types

There are two types of bankruptcy that a home owner can file: Chapter 7 and Chapter 13. In a Chapter 13 bankruptcy, there is an automatic stay (delay) of foreclosure proceedings for several months until such time as the bankruptcy is discharged in court, once a repayment plan with creditors has been established. During an automatic stay, all creditors (including a mortgage company) must cease all collection activity. The automatic stay is usually valid for three to four months.

A Chapter 7 filing allows the homeowner to live in the home for several months for free, allowing her to build up enough reserves to secure new living arrangements.

Time Frame

A Chapter 13 bankruptcy allows a homeowner to make payment arrangements on all debt in order to pay off any past-due payments on his mortgage. This can allow a homeowner to work out a repayment plan to pay off all late payments and late charges for a period of five to seven years, thus allowing him to keep his property and avoid foreclosure. However, if the homeowner is unable to sustain payments or does not have the income to justify a repayment plan, the mortgage company can continue the foreclosure process once the bankruptcy has been discharged, typically three to four months from the date of filing.

A Chapter 7 bankruptcy, conversely, allows the homeowner to live in the property for free during the three to four months it takes to close the bankruptcy. In some cases the homeowner is able to continue living in the property for two or three months even after the bankruptcy is complete.

Chapter 13 and Second or Third Mortgages

A Chapter 13 bankruptcy filing can, in some cases, cancel out debt owed to mortgage companies if the first mortgage on the property consumes the entire value of the home. This is beneficial for homeowners who are "underwater," meaning the property value has decreased, and it can classify a second or third mortgage as unsecured debt, i.e. debt that does not have to be repaid.

Chapter 7 and Cancelling Debt

With a Chapter 7 bankruptcy, a consumer's slate of debt is wiped clean. This relinquishes the consumer from having to repay unsecured debt or debt secured by her property. While this does not mean that she can keep her property, it does mean that she will not have a defaulted balance on her credit history, as she would have with a foreclosure. The entire amount of the defaulted mortgage is written off by the mortgage company.

Chapter 7 and Tax Liability

After a foreclosure, many consumers are subject to a federal tax liability if the foreclosure is filed by the primary mortgage holder on the property. This tax liability is the same if the consumer sold the property in a traditional retail market and will vary from situation to situation. A Chapter 7 bankruptcy filing can, in many cases, wipe out any tax liability in addition to debt.

Considerations

When considering a bankruptcy of any kind, consult a bankruptcy attorney. The attorney will help you decide what type of bankruptcy will be best for you based on your income, debt and financial situation. It is not advisable to file a bankruptcy on your own, especially in a foreclosure situation where many legal hurdles can arise.

References

• NOLO: How Bankrupty Can Help With Foreclosure
• Lect Law: Bankruptcy Information
• Foreclosure Fish: How Does Bankruptcy Affect the Lender's Pusuit of Foreclosure