Consequences of Declaring Bankruptcy on a Late Mortgage
If you fall behind on your mortgage, you may face foreclosure. If you cannot work out some type of deal with your lender, you may have to consider bankruptcy as an option to try to protect your home. Bankruptcy has the ability to at least temporarily delay foreclosure proceedings, and may offer you a way to keep up with your mortgage.
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Automatic Stay
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One of the main benefits of filing any type of bankruptcy is the automatic stay. The automatic stay protects you from any creditors at the moment you file your bankruptcy petition. Any type of contact, including phone calls, letters, wage garnishments and foreclosure proceedings, must stop when you file bankruptcy. While your mortgage lender may be able to successfully petition the court to remove the stay, you can get at least a few weeks or months of foreclosure protection by filing bankruptcy.
Chapter 13
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You have two consumer options when filing bankruptcy: Chapter 13 and Chapter 7. When it comes to protecting a home in bankruptcy, Chapter 13 is often the better option. For starters, Chapter 13 bankruptcy protects all property from court seizure to pay creditors. Additionally, Chapter 13 allows you to make up late mortgage payments through the three- or five-year payment plan that is mandatory in all Chapter 13 cases. As long as you can afford to continue making future mortgage payments, you can usually save your home in Chapter 13 and make up any late payments over time.
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Chapter 7
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Filing Chapter 7 may temporarily protect your home but ultimately cannot usually save a home from foreclosure. You can lose your home to the bankruptcy trustee if you file Chapter 7 and have home equity exceeding the allowable exemption amount in your state. Once your case is finished, you will usually lose your home through foreclosure if you cannot make your payments. Chapter 7 discharges your obligation to pay your mortgage, but does not eliminate the lien the mortgage lender has on your house. If you do not make payments to satisfy the terms of the mortgage, the lender cannot legally collect the balance from you but does retain the right to foreclose on your home.
Taxation
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If you are going to lose your home to foreclosure anyway, bankruptcy might at least help your tax situation. Generally, if a lender cancels or forgives any of your debt, the IRS considers that amount taxable income. For example, if you own a home worth $100,000 but owe $120,000 on your mortgage, the lender may cancel the $20,000 that you owe on that note through the process of foreclosure. That $20,000 is usually taxable income. However, if you discharge that debt in bankruptcy, it no longer becomes taxable income. For years 2007 to 2012, Congress enacted legislation to prevent forgiven mortgage debt from being taxable, but in most years, all forgiven or canceled debt is considered taxable income.
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