Filing for Chapter 7 bankruptcy will wipe out your mortgage obligation. Still, if you aren't willing to pay the mortgage, you'll have to give up the home because your lender's right to foreclose doesn't go away when you file for Chapter 7. Even though bankruptcy's automatic stay will stop the foreclosure temporarily, if you want to keep the house, you must continue paying your mortgage payment.
In this article, you'll learn:
If you're worried you'll lose your home if you file for Chapter 7 bankruptcy, consider filing for Chapter 13 instead. Chapter 13 can help you get your house out of foreclosure permanently.
When you file for Chapter 7, you erase your responsibility to pay your mortgage debt. You'll let the bankruptcy court and mortgagor know of your plan to let go of the house when you fill out your bankruptcy paperwork by checking "surrender" on the Statement of Intention for Individuals Filing Under Chapter 7 form.
It might seem that you can't keep a home in Chapter 7 bankruptcy, but it's not the case. You won't lose your home if you meet several requirements, which you'll learn more about in the "When You Want to Keep Your House" section below.
But first, we explain why you must pay your mortgage to keep your house even though Chapter 7 wipes out mortgage debt. The quick answer is that you agreed to give the lender a lien when you took out the mortgage.
A mortgage loan is a "secured debt." When you entered the loan contract, the lender created a lien on the property by taking the home as collateral to guarantee payment of the loan. When you put up your house as collateral, and you don't pay your mortgage, the lender can enforce its lien by foreclosing on the house. The house lien makes the mortgage a secured debt.
Here's the part that some people find confusing. Even though a Chapter 7 bankruptcy discharge wipes out your obligation to pay back the loan, it doesn't eliminate the mortgage lien. If it did, everyone could file bankruptcy and own their homes free and clear.
Instead, if you want to keep your home in Chapter 7, you must be caught up on your house payment or file for Chapter 13 and catch up on the arrears. If you file for Chapter 7, you'll also need to protect all of your home equity with a homestead exemption or a wildcard exemption. Otherwise, the Chapter 7 trustee appointed to administer your case will sell it.
Finally, you'll have to continue making timely mortgage payments after your Chapter 7 case ends. We explain more about mortgages in bankruptcy below.
You know that if you don't pay your mortgage payment, it won't be long before the lender forecloses on your home and sells it at auction to pay off what you owe, especially if you live in a "nonjudicial" state.
In a nonjudicial state, the lender doesn't need to file a lawsuit in court first. In judicial states, the lender must file a foreclosure action in state court first.
How quickly a creditor can take your property after falling behind on your payment often depends on whether the creditor is a "secured" or "unsecured" creditor.
A creditor with unsecured debt, like an unpaid credit card balance, can turn it into secured debt by suing you in court and winning. Some states automatically give judgment creditors a lien on your property.
In other states, the creditor can record the court judgment where your real estate is located or in a particular state agency to create liens on real and personal property. Also, a judgment creditor can garnish wages, levy a bank account, and seize property.
A lien can be voluntary—you agreed to the lien—or involuntary. The difference matters because most voluntary liens are limited to a particular asset, such as a home, car, or boat. For instance, a mortgage lien applies to the house purchased with the home loan.
However, an involuntary lien might extend to more assets. Here's how voluntary and involuntary liens work.
Voluntary liens. Typically, secured creditors include mortgage companies and car lenders. In both transactions, the borrower voluntarily agrees to guarantee the loan by giving the lender an interest or lien in the property purchased or "collateral." For instance, when taking out a home loan, the borrower provides the lender with a lien by agreeing to put up the house as collateral.
If the homeowner falls behind on the payment, the bank can initiate a foreclosure proceeding, sell the home at auction, and use the proceeds to pay down the loan. A car buyer gives a lender similar lien rights when financing a vehicle. If the borrower doesn't pay as agreed, the creditor repossesses the car, sells it at auction, and applies the money toward the loan balance.
Involuntary liens. Not all liens are voluntary. If you fail to pay your income taxes, the federal government can obtain an "involuntary" lien without your consent. An involuntary "judgment lien" can be created after an unsecured creditor files a collection lawsuit in court and wins a money judgment.
A lien also gives a secured creditor the right to get paid before other creditors—including in bankruptcy. If the trustee sells the property encumbered by a lien in a Chapter 7 case, the trustee must pay the secured creditor before paying other creditors. If the property has multiple liens, the trustee will pay each lien according to the "first in time" rule, paying the earliest lien first.
Example. Josh financed a $20,000 sailboat with the Big Boat Company. As part of the contract, he agreed to give Big Boat a lien on the sailboat. Three years later, Josh filed for Chapter 7 bankruptcy. His debt totaled $120,000, $5,000 of which he still owed to Big Boat. The trustee sold the sailboat for $15,000. Because Big Boat had a lien against the boat, the trustee paid Big Boat the balance of $5,000 and distributed the remaining $10,000 (minus trustee fees) to the other creditors.
In a Chapter 13 case, the filer must have sufficient income to pay all monthly secured payments, such as a house or car payment. If any funds remain, the trustee will distribute them to the unsecured creditors.
Example. Jessie filed a Chapter 13 case to stop a foreclosure sale. She was required to make a monthly payment of $2,500 for five years. Out of the monthly payment, the trustee paid $2,100 to the mortgage company (the monthly payment plus a portion of the mortgage arrearages) and a $300 car payment. The trustee divided the remaining $200 between Jessie's unsecured creditors—three credit cards, an overdue electric bill, and an unpaid gym contract.
Lien stripping is a Chapter 13 benefit that allows a qualifying filer to remove a junior lien, such as a second or third mortgage lien, from a house, but only when the balance of the senior lien or liens exceeds the property value.
Lien stripping isn't available in Chapter 7 bankruptcy. If you keep the house in Chapter 7, all liens will remain, and the lender on each loan can exercise lien rights to take the home if you fall behind on your payments. You'll have to pay all loans as agreed to keep your house.
But you should know about lien stripping if you owe more than your house is worth because if you qualify for lien stripping, you might be better off filing for Chapter 13. Learn more about stripping a junior lien in Chapter 13.
Most people who want to keep their home will ensure they're current on their mortgage payments before filing for Chapter 7 bankruptcy. They also need to be able to protect all of the equity with a bankruptcy exemption.
If you're behind on your payment and need time to catch up on your arrears, Chapter 7 won't be the right chapter because it doesn't provide a way to make payments over time.
Instead, consider filing for Chapter 13 bankruptcy. Chapter 13 is the chapter that allows filers to catch up on payments and keep property, making it the better choice. You'll be able to stretch out your missed payments over a three- or five-year repayment plan.
Many people wonder how much time must pass before they can get an FHA, VA, or conventional home loan after filing for Chapter 7 bankruptcy. While it will depend on the program and your circumstances, getting a home loan two to four years after a Chapter 7 case is possible.
Rebuilding your credit and earning enough income to qualify for a real estate loan are goals you'll want to set after your Chapter 7 case ends. If this seems daunting, have hope. Many people receive credit offers soon after bankruptcy. If you research rebuilding credit after bankruptcy, you'll likely be back on your financial feet and buying the house of your dreams soon.
Did you know Nolo has been making the law easy for over fifty years? It's true—and we want to make sure you find what you need. Below you'll find more articles explaining how bankruptcy works. And don't forget that our bankruptcy homepage is the best place to start if you have other questions!
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