Chapter 7 bankruptcy will delay a foreclosure but won't block it permanently. You’re more likely to be able to keep your house if you file for Chapter 13 bankruptcy (see our article on stopping foreclosure with Chapter 13 bankruptcy). But even if you think you’ll need to give up your house sooner or later, Chapter 7 bankruptcy can still be very valuable when you’re facing foreclosure.
Filing for Chapter 7 bankruptcy offers different benefits, depending on your situation.
If you want to keep your house and are current on your first mortgage, you can get other debt canceled, freeing up money to put toward payments on your first mortgage. If the home’s value is less than the first mortgage, then a Chapter 7 bankruptcy can have the practical effect of eliminating (at least temporarily) the need to make payments on a second or third mortgage after your bankruptcy. This is because your bankruptcy will eliminate the debt owed under the second or third mortgage (which means the owners of these debts can’t sue you for money) and a foreclosure by the holder of the second or third mortgage will be off the table because by definition the proceeds of the foreclosure sale would all go to the first mortgage holder (see our article on how Chapter 7 bankruptcy can help you keep your house). Of course, if your home sufficiently appreciates in value to substantially exceed the amount you owe on the first mortgage, a second or third mortgage lien may then potentially have to be dealt with if you wish to sell or refinance your home.
If you decide to give up your house, you can:
delay foreclosure proceedings for two to four months, and
get all or most of your debts permanently canceled so that you can have a fresh start after foreclosure.
Bankruptcy is a wonderful way to deal with the various liabilities that you might incur while holding off a foreclosure or going through one. Simply put, with a few exceptions, the debts all go away. And that’s not all, as they say in the late-night TV ads. Credit card debts, medical bills, and most money judgments arising from lawsuits over breach of contract or negligence go away as well. So if you are up to your neck in these types of debt, bankruptcy is something to seriously consider, whether you want to free up income to pay your mortgage (by decreasing your debt load) or whether you are headed towards a foreclosure and want to get a fresh start.
Of course, bankruptcy is not for everyone. There are the obvious psychological barriers; no one likes to admit that bankruptcy is really necessary. And if you’re concerned about rebuilding your credit as soon as possible, bankruptcy might best be avoided entirely. In these turbulent times, it’s impossible to tell what kind of a hit bankruptcy will have on your credit or for how long.
If you’re interested in modifying your mortgage, see a HUD-approved counselor before you file for bankruptcy. If you are seeking a modification of your mortgage principal or payments, or are attempting to refinance your current mortgage either in or out of the federal government's Making Home Affordable program, talk to a HUD-approved housing counselor before filing bankruptcy. If you're negotiating a HAMP modification, the bank will suspend the process until after you receive your discharge. Under regulations applicable to HAMP modifications, any new mortgage will contain language stating that you cannot be required to reaffirm the old mortgage debt as a condition of obtaining a modification. Also, the servicer cannot deny you a modification just because you were able to discharge the underlying debt in a Chapter 7 bankruptcy. If, however, you don't qualify for a HAMP modification, your servicer may reject your modification request due to your bankruptcy under its own non-HAMP policies.