While Bankruptcy is one of the most cost-effective and efficient legal meansof walking away from an underwater or foreclosed home available, it is also, under the right circumstances, a better means of saving a home in danger of foreclosure than other non-bankruptcy strategies, such as mortgage modification.
Surrendering a home in bankruptcy enables you to walk away from the property without fear of either future collections or of a negative taxable consequence, without any negotiation with the bank holding your mortgage required. If you live in a so-called “deficiency state" like Michigan, lenders can pursue you for the balance of your debt on a mortgage after a foreclosure in most circumstances. A bankruptcy prior to walking away will prevent that from happening.
However, you may not want to walk away from your home. If your home is underwater or over-mortgaged only because of the presence of a second or even third mortgage on your home, it may be possible to remove those secondary mortgages with a Chapter 13 reorganization bankruptcy. If you are in danger of foreclosure only because you have missed some payments, a Chapter 13 can also give you an opportunity to make up those payment deficiencies while under the protection of the Bankruptcy Court, free from fear of threats of foreclosure.
In other words, there are a couple of different ways that you can save your home with bankruptcy. Both require the filing of a Chapter 13 Bankruptcy, which is essentially a payment plan running 36-60 months. In a Chapter 13 payment plan, you pay secured debt first, then other types of debt last—and only then to varying degrees.
When a Chapter 13 Bankruptcy is filed, a master discharge under Federal Law called the “automatic stay against collections" clicks into place, preventing any foreclosure currently underway from proceeding, as well as any other action by any creditor that would constitute a debt collection attempt.
With that automatic stay in place, you propose to the Bankruptcy Court through your Plan a repayment scheme:
First, to cure a mortgage arrearage, you propose paying each month the basic contractual mortgage payment you are required to pay on your first mortgage.
Next, if there is an arrearage or deficiency in your payment history that has triggered a foreclosure process by your mortgage lender, you propose paying off that arrearage as a lump sum with some interest over the period of your Plan. For example, if you were $5,000 behind in your mortgage payments and proposing a 60-month Chapter 13 Plan, you would propose paying $5,000 divided by 60, with interest.
Thus, when you exit your Chapter 13 Plan in no more than 60 months and in as few as 36 months, you would have maintained your mortgage payment and cured any deficiency, resolving the need for a foreclosure and saving your home.
In addition, as mentioned, you may also be able to discharge a second or third mortgage on your home. If you home is worth less than you owe on a first mortgage in fair-market value terms, your second mortgage is not actually secured by the value of the collateral securing that loan—the house.
In the Eastern District of Michigan, where I practice, I must file a sort of lawsuit for my clients in bankruptcy court, along with the filing of their petitions and Chapter 13 plans, to accomplish a stripping off of this lien. The outcome of this lawsuit is a declaration by the bankruptcy court that this is not, in fact, a secured debt but actually an unsecured debt, like a big credit card, essentially. And that debt, once declared to be unsecured, is paid only after all other secured and priority creditors are paid in your Chapter 13 plan, and they receive only what is left of your Plan payments at that time, the balance of your debt being totally discharged, permanently, and the lien removed from your home upon completion of your Chapter 13 plan.
This process may be different depending on your jurisdiction.
If a foreclosure is imminent, you have a steady stream of income, and you would like to save your home without spending a year or more negotiating with your mortgage creditors, a Chapter 13 Bankruptcy may be a viable option for you.