Chapter 7 Bankruptcy and Foreclosure

Chapter 7 cannot permanently prevent foreclosure, but it might help in other ways.

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If you are facing foreclosure, Chapter 7 bankruptcy won't permanently stop the foreclosure on its own. However, filing for Chapter 7 may help in other ways, like delaying foreclosure, freeing up other money to pay your mortgage, and ensuring that you don't pay taxes on a deficiency after the foreclosure. 

The Automatic Stay Delays Foreclosure

When you file a Chapter 7 bankruptcy petition, most creditors are instantly prohibited from continuing collection efforts against you. This is called the "automatic stay." (To learn more, see Bankruptcy's Automatic Stay.)

The automatic stay does apply to foreclosures -- your lender must cease foreclosure efforts while your bankruptcy is in progress (but the lender can continue to foreclose once the bankruptcy is completed). 

However, your lender can (and probably will) ask the court to lift the automatic stay before your bankruptcy is completed. If the lender can prove that it is the legal holder of the mortgage or deed of trust to your home, the court will most likely lift the automatic stay and allow the foreclosure to proceed.

Is your lender the mortgage holder? Although you might think that your lender/the foreclosing company can easily prove that it owns the mortgage or deed of trust, this is not always the case. Because mortgages have been bought, sold, lumped together, and electronically repackaged frequently in recent years, the institution trying to foreclose may not be able to provide the required proof to the court. If so, the automatic stay will remain. While this may seem like a victory, you will likely only gain an additional month or two delay, because the judge decides whether to lift the automatic stay a couple of months into the bankruptcy, and the bankruptcy itself usually only lasts three and a half months.

Saving Money Due to Foreclosure Delay 

Delaying foreclosure by even a few months can be financially advantageous to the homeowner. For instance, if your mortgage payment is $2,000 a month, you can save $6,000 or $7,000 just in that short period by not having to make payments.

Even if the lender is successful in lifting the automatic stay, you will likely get an additional number of free months in the home, due to delays that are part of the normal foreclosure process and the failure of the bank or new owner to immediately take the steps necessary to evict you. (To learn more, see our Foreclosure area.)

Discharge of Other Debt Means More Money for Your Mortgage

If you are current on your mortgage and your home isn't worth enough to trigger a sale in your bankruptcy (to learn more, see Your Home in Chapter 7), then the cancellation of other unsecured debt in a Chapter 7 bankruptcy can help you stay in your home by freeing up money that you can then use to pay your mortgage.

Tax Advantages If Your Home is Sold in Foreclosure

Chapter 7 bankruptcy will cancel your mortgage and all other debts secured by your home, such as a home equity line of credit -- even though the liens created by these debts will remain in place. This has distinct tax advantages if you lose your home in foreclosure.

Normally, if you lose your home in foreclosure and the amount the lender gets in the foreclosure sale doesn't cover the amount remaining on your loan, the difference is treated as "forgiven debt." You might owe taxes on this debt. However, since there is no debt after bankruptcy, there is no "forgiven debt" to tax. (Even if you incur a forgiven debt tax before you file for bankruptcy because of a previous foreclosure, other rules make payment of the tax unlikely.) To learn more, see Canceled Mortgage Debt: What Happens at Tax Time?

by: , Attorney

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