How Bankruptcy Can Help With Foreclosure

If you are facing foreclosure, bankruptcy might help. In many cases, filing for Chapter 7 bankruptcy can delay the foreclosure by a matter of months. Or if you want to save your home, filing for Chapter 13 bankruptcy might be the answer.

(To compare the two bankruptcy types, read Should I File for Chapter 7 or Chapter 13 If I Want to Keep My Home?)

What Is Foreclosure?

Typically, a foreclosure begins after a homeowner falls behind on mortgage payments. The lender must follow the process outlined in state law before selling the home at auction. The lender applies the sales proceeds toward the mortgage balance. Whether the lender will be able to collect any remaining balance from the borrower—called a deficiency balance—will again depend on the laws of the state. The process involves numerous steps, including notification to the homeowner.

Fortunately, the bankruptcy process won't happen overnight. Usually, a lender won't begin the foreclosure process until you've missed several payments, often three or four. That gives you time to try some alternate measures, such as loan forbearance, a short sale, or a deed in lieu of foreclosure. (You can learn more about your options in Foreclosure: The Basics.)

But if you've already tried and failed with these measures, it makes sense to consider whether bankruptcy can help you avoid foreclosure, or at least buy you a little time. Here are some ways that filing for bankruptcy can help you.

The Automatic Stay: Delaying Foreclosure

When you file either a Chapter 13 or Chapter 7 bankruptcy, the court automatically issues an order (called the order for relief) that includes a wonderful thing known as the "automatic stay." The automatic stay directs your creditors to cease their collection activities immediately.

If your lender had scheduled your home for a foreclosure sale, and you file for Chapter 7 bankruptcy, the sale will be legally postponed while the bankruptcy is pending—typically three to four months. However, the lender can ask the bankruptcy court for permission to proceed with the sale by filing a "motion to lift the automatic stay." If successful, you won't get the full three to four months.

But, even so, it takes time for the motion to be filed and heard, so the bankruptcy will typically postpone the sale by at least two months, or even more if the lender is slow in pursuing the motion to lift the automatic stay. (Learn more in Bankruptcy's Automatic Stay.)

How Chapter 13 Bankruptcy Can Help

Many people want to remain in their home and will do whatever they can to stay in their home for the indefinite future. If that describes you, and you're behind on your mortgage payments with no feasible way to get current before foreclosure, the only way to keep your home is to file a Chapter 13 bankruptcy.

How Chapter 13 works. Chapter 13 bankruptcy lets you pay off the "arrearage" (late unpaid payments) over the length of a Chapter 13 repayment plan you propose—five years in most cases. But, you'll need enough income to meet your current mortgage payment in addition to paying off the arrearage. Assuming you make all the required payments up to the end of the repayment plan, you'll avoid foreclosure and keep your home.

2nd and 3rd mortgage payments. Chapter 13 bankruptcy might also help you eliminate the payments on your second or third mortgage. Here's how it works. If your first mortgage is secured by the entire value of your home (which is possible if the home has dropped in value), you might no longer have any equity with which to secure the later mortgages. That allows the Chapter 13 court to "strip off" the second and third mortgages and recategorize them as unsecured debt—which, under Chapter 13 bankruptcy, takes last priority and often does not have to be paid back at all. As home equity rises, this approach is used less frequently. (Learn more in Getting Rid of Second Mortgages in Chapter 13 Bankruptcy.)

Nonexempt equity. The great recession hit home equity hard, and it was unusual for a bankruptcy filer to have much, if any, equity in a home. Since that time, home values have continued to climb. Now a filer must carefully consider the ability to fully protect equity with the homestead exemption allowed by filer's state. If the homestead exemption isn't sufficient, to keep a house, a filer will have to pay the value of the nonexempt property in the repayment plan, too.

For more information, see Your Home and Mortgage in Chapter 13 Bankruptcy.