Filing for Chapter 7 bankruptcy eliminates your personal liability for your mortgage loan. However, Chapter 7 does not get rid of your lender’s right to foreclose on its lien. As a result, you must still continue to pay your mortgage if you want to keep your home. Read on to learn more about how filing for Chapter 7 affects your mortgage.
When you take out a mortgage, you enter into a contract with your lender promising to pay back your loan in full. You can do this by paying off the loan through regular payments, refinancing through another lender, or selling the house. However, if you stop making mortgage payments (and you can’t refinance or sell your house for enough money to pay off your mortgage), your lender can force the sale of your home through foreclosure to get paid on its loan.
If your house is sold through foreclosure but the sale proceeds are not enough to pay off your mortgage balance, you may be responsible for the difference. This is called a deficiency. Whether your mortgage lender can go after your personal assets to collect a deficiency depends on your state’s laws. However, even within the same state, the result can vary depending on how many mortgages you have, whether your first mortgage lender or a junior lienholder is foreclosing on your home, or if you took out your mortgage to purchase your home or later.
A Chapter 7 discharge eliminates your personal liability for mortgage loans. This means that even if you live in a deficiency state, you are no longer in danger of your lender coming after you personally to collect a mortgage deficiency.
In addition to your personal liability for the loan, your mortgage lender usually has a lien on your home. If you don’t pay your mortgage, the lender can enforce its lien by foreclosing on the house. As a result, your mortgage lender is classified as a secured creditor in your Chapter 7 bankruptcy.
Even though your Chapter 7 discharge wipes out your personal obligation to pay back the loan, it doesn’t eliminate the mortgage lien. If it did, everyone could file bankruptcy and then own their homes free and clear. When you file for Chapter 7, your mortgage lender still has the right to foreclose on your house if you default on the loan. As a result, if you want to keep your home, you need to continue making timely mortgage payments.
(Learn more about how Chapter 7 affects your home mortgage.)
You may have heard of lien stripping in bankruptcy. Lien stripping is the process of removing junior liens (such as second or third mortgages) from your house if the balance of your first mortgage (or other senior liens) exceeds the value of the property.
Lien stripping is not available in Chapter 7 bankruptcy. However, if you are upside down on your home, you may be able to strip your junior mortgage liens through Chapter 13 bankruptcy. In that case, it may be more advantageous to file for Chapter 13 bankruptcy even if you qualify for Chapter 7.
(Find out if you can strip off a junior lien in Chapter 13.)