What happens to your mortgage when you file for bankruptcy?
Bankruptcy can help you manage your debt and financial obligations, but it could also impact your ability to keep your home.
That’s right, about 27.9% of people who file for bankruptcy lose their homes in foreclosure.
But it's not all doom and gloom if you’re considering bankruptcy to get your finances back on track. Losing your home when you file for bankruptcy is incumbent on:
- What type of bankruptcy you are filing
- Whether you are up to date on mortgage payments
- And how much equity you have in your property
So, how exactly does bankruptcy affect your mortgage?
How home equity and exemptions affect bankruptcy
What happens to a mortgage in bankruptcy? The short answer is you still have to pay it unless you've exhausted all your options and have no choice but to forfeit your home.
But being bankrupt doesn’t necessarily mean you have to lose your house. That’s because home equity and homestead exemptions come into play.
Confused? Keep reading.
Home equity is the difference between the value of your home and the amount you owe on your mortgage. In bankruptcy, it partly determines whether you keep your home and how much you must pay creditors.
Let's say the market value of your home is $200,000, and you still owe $100,000 on your mortgage.
That means you have $100,000 in equity because if you sold your home, you'd net that much after paying off your mortgage.
Then, there are homestead exemptions to consider. These legal mechanisms shield your primary residence from property taxes, creditors, and sometimes foreclosure.
For example, in California, homestead exemptions are $75,000, meaning the bankruptcy court would only consider what came after that amount as equity. In this example, it's $25,000.
In a Chapter 7 bankruptcy, if the value of your home is less than the homestead exemption, it is exempt from bankruptcy because selling it would yield very little.
If your home is worth more than the homestead exemption amount and you have considerable equity, the court may decide to sell it to settle your debts. To prevent foreclosure, you could file for a homestead exemption.
It's easy to see that bankruptcy is a complex process, so it's best to consult a lawyer to determine which type is more favorable for you, and what you can do to protect your real estate interests.
Different types of bankruptcy
If you have a mortgage in foreclosure or a high amount of home equity, you'll probably opt for Chapter 13 rather than Chapter 7 bankruptcy so that you can keep your home.
Chapter 7 bankruptcy
Before filing for Chapter 7 bankruptcy, you should reach out to your lender to explore the possibility of modifying your mortgage agreement to make it more affordable.
Many lenders will reduce the interest rate, decrease the total debt owed, or extend the repayment period so you can continue paying your mortgage and avoid foreclosure.
If you file for Chapter 7 bankruptcy, any equity in your property can be sold to satisfy any outstanding financial obligations, with the remaining funds going to you.
You will only lose your home if the proceeds from the sale of your assets and home equity are not sufficient to clear all your debts.
Chapter 13 bankruptcy
Unlike Chapter 7 bankruptcy, which eliminates all debt, Chapter 13 bankruptcy allows you to restructure debt and pay it off over time, consolidating mortgage arrears and other debt into a three to five-year payment plan.
During this time, mortgage lenders may not pursue home foreclosure if you keep up with the restructured repayment plan to pay past due and current monthly payments.
Besides bankruptcy, other debt-relief alternatives can provide more favorable terms while protecting your credit score, home, and future loan opportunities.
Debt settlement is a process where you negotiate with your creditors to pay less than the total amount you owe.
It reduces your debt burden, but it is essential to understand the risks involved—a damaged credit score, additional fees, and no guarantee your lenders will accept it.
The steps involved in debt settlement are:
- You work with a debt settlement company to negotiate with your creditors
- The debt settlement company contacts your creditors and offers them a lump sum payment for less than the total amount you owe
- If the creditors agree to the settlement, you will stop making payments on your debt and instead send payments or a lump sum to the debt settlement company until you have accrued enough to pay your negotiated debt amount
- The debt settlement company will then distribute the money to your creditors
Debt consolidation is when you take out a new loan to pay off your debts. Instead of making multiple payments, you make one, ideally at a lower interest rate.
The steps involved in debt consolidation are:
- You apply for a debt consolidation loan
- Once approved for the loan, you receive a lump sum
- You use the lump sum to pay off your debts
- You then make monthly payments on the debt consolidation loan
Debt consolidation can be a good option if you have multiple debts with high interest rates.
Balance transfer cards
A balance transfer credit card is a credit card that offers an introductory promotional 0% APR (annual percentage rate) on balance transfers for a specific time, typically 12 to 18 months.
You can transfer your existing credit card debt to the balance transfer card and not have to pay any interest on it for the promotional period.
The steps involved in a balance transfer:
- You apply for a balance transfer credit card
- If approved, you will receive a credit limit
- You will transfer your existing credit card debt to the balance transfer card
- You will then make monthly payments on the balance transfer card
Possible options for a balance transfer include, but aren't limited to, the Chase Slate®, Citi® Diamond Preferred®, and Discover it® Balance Transfer℠ cards.
Understand the impact on your mortgage
In most bankruptcies, your mortgage can't be discharged, but depending on the type you file, you can modify the loan terms, e.g., interest rate reduction or re-amortization for a lower monthly payment.
While bankruptcy is one way to eliminate other debts, it is essential to consider the potential impact on financial well-being and lifestyle because you may risk losing all your assets, including your home.