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Mortgages in Bankruptcy: How Secured Debt is Handled in a Bankruptcy

Mortgages in bankruptcy can be discharged, but the lien remains absent specific circumstances

When considering bankruptcy, many people ask to leave their mortgage out of the bankruptcy. This is not possible; you must include all your debts. However, a mortgage is treated differently than your credit cards or personal loans, it is secured against property.

Most individuals cannot afford to buy a home outright. They need help of buying a property with a mortgage. This mortgage is a lien against the property. The lien allows the mortgage company to take back the property if the terms of the loan are not followed. It also requires that the mortgage loan be paid back in full if the property is ever sold or transferred.

A second mortgage is usually referring to a junior debt that is secured against a property. This could be a loan that was obtained at the time of purchase or years later. A second mortgage could be a home equity loan with revolving terms, often referred to as HELOC, or a traditional 15 or 30 year loan.

There is a common misconception that second mortgages retain limited rights. Second mortgages have basically all the same rights as a first mortgage, only the junior mortgage is second in line in interest on a property. Often a second mortgage will not proceed with a foreclosure due to the fact they must either foreclose subject to the first mortgage or pay the first mortgage off.  But, if there is enough equity in a property, it can make perfect financial sense for a second mortgage to foreclosure.

Our office has even seen second mortgages foreclose when there is minimal equity after a first mortgage. This may occur because a creditor wants to limit the debtor’s ability to incur anymore debt through late payments, fees, interests, etc.

Chapter 7

Many people use a Chapter 7 as a tool to stop a foreclosure or keep a mortgage company from coming after them. If you cannot afford your house, and the property is worth less than what is owed on the property (or there is only de minimus amounts of equity), then a Chapter 7 can be a great tool. Filing Chapter 7 can ensure that debtors are not responsible for any deficiencies that remain after a foreclosure (basically any balance of the loan(s) that a foreclosure sale does not satisfy). Additionally, if the bankruptcy happens prior to a foreclosure being completed, it keeps a debtor’s credit cleaner; a foreclosure would not appear on a debtor’s credit because he/she would not longer have any obligation to pay on the debt at the time the foreclosure happened.

A Chapter 7 only takes care of the in personum obligation of a debtor. Basically, a discharge in a Chapter 7 covers the Debtor’s obligation to pay on their mortgage. A mortgage company cannot force a debtor to pay after a Chapter 7; additionally, if there is a foreclosure, a mortgage company cannot try to collect on any deficiency from the debt. However, in a Chapter 7, the lien remains on the property – this applies to all mortgages. This means that a mortgage company can still foreclose on the property to retake the collateral. A foreclosure against only the property , also referred to as an in rem proceeding.

If you reaffirm a mortgage during your bankruptcy, then all obligations for the mortgage return. The mortgage company can come after the debtor for any unsatisfied obligation.

Mortgage Liens Remain After Chapter 7

Many individuals come to see an attorney years after their bankruptcy. They are confused about why the second mortgage company is trying to foreclose. They say that the their bankruptcy included the second mortgage. Sometimes, the debtor even continued to pay the first mortgage. Usually this confusion comes in because their attorney did not explain the difference in the personal obligation and the lien.

The same terms of the all mortgages remain with the lien after the Chapter 7 bankruptcy. Your mortgage lender may be willing to do a modification to lower your interest and payments, but they are not required. If you do not comply with the terms of the debt, the mortgage company can foreclose.  On a rare occasion, a second mortgage may reduce the balance or forgive a debt after a bankruptcy. This is usually done, if they believe it is not in their best interest to continue having the outstanding liability or that a tax reduction for writing off the loan is in their best interest.

Chapter 13

In a Chapter 13, you must submit a plan to the court explaining your intent with the property. This plan will tell the court if you plan to keep or give up a property. It also likely will tell the court how you plan to repay any arrerages on the property.

A Chapter 13 can be a great tool to help a debtor catch-up on a first and/or second mortgage. A Chapter 13 would allow a debtor to pay back arrearages over the course of 3 to 5 years. While paying back the arrearage, you must also continue to make your regular payments to the mortgage company.

2nd Mortgage Strip off

One very special reason some people file Chapter 13 is to strip off the second mortgage. This process can only occur in a limited number of circumstances. Basically, a second (or even a third or fourth) mortgage can be removed from a debtor’s property if it is wholly unsecured. This means that the value of the senior mortgage is greater than the fair market value of the property. If the property is worth even a penny more than the balance of the first mortgage, then it is considered that the second mortgage has something to attach to and cannot be removed through a Chapter 13 strip off.

In a strip off, the debtor must file a separate lawsuit within his/her bankruptcy. The bankruptcy court must determine the property value is less that the mortgage(s) senior to the mortgage being removed. If the court determines that to be appropriate then the court issues an order that the lien must be treated as unsecured for the rest of the bankruptcy and after the Chapter 13 plan is complete, the liens of the junior mortgage(s) are removed.

With housing prices on the rise and increasing back to pre-2007 levels, this process is getting less common, but it still will be completed from time to time.

Court Orders are Required to Remove any Lien

The rule of thumb at the end of the day is that bankruptcy usually only takes care of personal liabilities. Liens are a special situation; no lien or mortgage can be removed from property unless there is a court order from a judge, the debt is completely satisfied, or the creditor agrees to voluntarily release the debt. Any creditor with a mortgage lien can foreclose on a property as long as the lien is valid.

 

 

Attorney Ashley F. Morgan is a Virginia licensed attorney. She has been helping clients stop foreclosures using bankruptcy and non-bankruptcy options.  Ashley has successfully helped many debtors strip off second mortgages from their properties. She has also helped numerous individuals catch-up on their mortgages and save their homes through a Chapter 13 plan.

Scrabble letters of bankrupt

Options When You Are Facing Foreclosure

Many people walk into my office looking for advice about bankruptcy. Often, major life events drive people to consider bankruptcy, such as divorce, significant illness, foreclosure, etc. Foreclosure is an especially interesting reason to consider bankruptcy because it provides options to either limit liability and/or help handle any arrearages. It really can help those who are in default with their mortgage; however, bankruptcy is not always the only option.

Foreclosure can affect anyone. Maybe you were the perfect borrower; you made all your payments on time, even prepaying a little every month. Or maybe you had trouble making your mortgage payments, but you worked two jobs, got renters in your house, and did everything in your power to make the payments. Your payments were sometimes late, but never more than 30 days. Nonetheless, one day, you lose your job, you get sick, you are in a car accident, or something else happens and you cannot make your payments. You get one month behind, then two, and then a few more. Finally, a notice from your lender appears in your mailbox – your account is being referred out for foreclosure.

Most lenders only start the foreclosure process when you are three months behind or more. If you are approaching three months or more, then you really need to consider whether you will be able to bring your account current or if there any other options available to you. In some states, the foreclosure process is slow and can take months or years. In other states, after the foreclosure process starts you only have two months. For example, in Virginia, the foreclosure can occur in as little as two to three months after you get notice you are in default. Being proactive with your situation can help alleviate the stress and panic. However, if you have not considered your options prior to getting notice from your lender, then you should immediately figure out a plan and start talking to the right people. You do have various options, and it is important to understand them.

  1. Seek a loan modification with your lender.

Lenders can sometimes understand that life happen. As a result, from time to time you can get them to work with you. For example, you lost your job and could not make your mortgage payment for six months, but now you have a new job. You have no problem making your mortgage payment going forward but cannot quickly pay off the money you are behind (the arrears). A modification can potentially spread your arrears over the course of the life of your loan or potentially tack them on to the end. For another example, maybe you did not lose your job, but your hours at your job have been cut. You can still make a mortgage payment, but not the full mortgage payment each month. A modification can sometimes lower your interest rate and potentially lower your payment.

A modification may seem like a miracle, and for some it is. Often it is a great option when you can make payments, but need a little help either with your payment amount or arrearages. The first step in getting a modification is often talking to your lender and giving them a heads up about the situation. A modification is at the sole discretion of your lender – they do not have to offer you one and they do not have to give you one. But, it cannot hurt to try and often it is beneficial for them as well. Your lender will ask for significant amounts of information and documents. Make sure you get the documents to them as quickly as possible.

Beware of the companies out there that advertise offering modifications services. Many of these services are scams. There are some individuals and companies that are legitimate and can really help with the process, and even make the situation easier for you. If you want/need help with the modification process make sure you find a legitimate company. Ask people for recommendations and search the web for reviews.

  1. File Chapter 13 to help repay arrearages.

If a loan modification does not work, or is not an option at the time, there is the option of a Chapter 13. In a Chapter 13, the Bankruptcy Court basically helps you work out a repayment plan. This is for those individuals with regular income. The repayment plan allows you to make your normal mortgage payment going forward, while also making monthly payments to the court in order to catch up on your arrears. Plans are usually payments over the course of three to five years. The other benefit of a Chapter 13 is that it can help you handle all the rest of your debt, whether it is tax issues or credit card debt. The plan payments are approved by the court, and the amount is based on your income and expenses that the court determines are reasonable, as well certain assets. The plan must pay your arrearages and other important debts such as taxes. Your plan may also pay unsecured creditors anywhere from 0% to 100%, it just depends on what your payments will be.

The benefit to a Chapter 13 is that if you can afford to catch up over the next three to five years and bring your mortgage current, the bank has to accept the plan. A modification is optional for the lender, bankruptcy is not. However, the downside is that it is up to the court to determine whether your plan is feasible. For many, they make expect to be making more money a year or two down the road, but without proof (such as a contract or a guaranteed future lump sum payment), it is too speculative and the court will not allow approve your plan. An experienced bankruptcy attorney can help point out the pros and cons of a Chapter 13 in your situation, and whether a plan would even be feasible in your situation.

  1. Sell your home to take advantage of your equity.

If there is no way to bring your loan current, and there is equity in your home, you should consider selling it. A bank does not want to sell your home; selling your home means it costs them time and money. Also, if a bank forecloses, the possibility of you receiving any of the equity in the home in slim to none. If you sell the home, you can take that money and do what you want with it. Sometime, if you are actively trying to sell your home or you get a contract of the house, a lender will delay the foreclosure. But, just like a modification, it is in their sole discretion. Having an experienced realtor on your side in this situation is important. You need a realtor who not only knows how to act quickly, but who has also dealt with lenders before. An experienced realtor can present your situation to the lender in the most effective way and be your advocate.

If there is no equity, a short sale may be an option. This allows you to sell your house for a loss (and not pay off the entire mortgage). There can be tax consequences to a short sale and the lender may still come after you for a deficiency.

  1. File Chapter 7 to stop to limit liability and stop the foreclosure.

If there is little or no equity in your home, and you have decided you likely cannot save it, then you may want to consider a Chapter 7 bankruptcy. A Chapter 7 can stop a foreclosure and give you enough time to figure out where you want to go. The bankruptcy also discharges your obligation to pay on the mortgage. While the lien will continue to exist on the property, the bank will foreclosure against the property after the bankruptcy is done and you will not be responsible for any deficiency on the property. This can also help wipe away any other unsecured debt that you may have. Importantly, after a bankruptcy, a debtor only must wait two years to qualify for a mortgage. If you allow the lender to foreclose or you file bankruptcy AFTER the foreclosure then you must wait 7 years to qualify for a mortgage.

Not everyone can qualify for a Chapter 7. The bankruptcy court does consider your income and number of dependents in determining whether you can file a Chapter 7. If you cannot qualify for a Chapter 7, a Chapter 13 (that is discussed above) can be an option to surrender the house and limit any potential liability after the foreclosure. An experience bankruptcy attorney can help talk to you about the pros and cons of filing a bankruptcy and whether you could qualify.

  1. Do nothing and let the foreclosure happen.

Sometimes, if you have to deal with other issues in your life and you just want to walk away from the house, doing nothing is your best option. If you do nothing to stop the foreclosure, it will proceed. The bank will continue with its course of action and after the sale, the house will no longer be your responsibility. There are many factors to consider here. After a foreclosure, you cannot qualify for a mortgage for 7 years. You will also be liable for any deficiency on the house after the sale. You lender can try to collect this remaining debt by taking you to court or garnishing part of your paycheck or your bank account. Even considering these negative factors, sometimes doing nothing is the best option. However, usually you can only come to this decision after reviewing your entire situation and considering all options.

It is important to remember, all of these options should be considered in conjunction with each other. For example, if you are seeking a loan modification, you can still talk to a realtor so you have a backup plan. Similarly, you may also want to consult a bankruptcy attorney, so you can be prepared in case you cannot sell the house or the modification is unsuccessful. Similarly, a modification may also be an option while in a Chapter 13 or after a Chapter 7, it all depends.

Just remember, sometimes Plan A works, but if it fails and you do not have a backup plan (or two), you can find yourself out of luck. Up until the day of the foreclosure you have options – take advantage of that time. Talk to a bankruptcy attorney today. Timing can be an issue, especially if you have the option of selling your house or filing bankruptcy. Make an appointment with a bankruptcy attorney as soon as the possibility of foreclosure arises. Most bankruptcy attorneys offer free consultations, as does my office. Having more knowledge and information never hurts. Understanding all your options can only help you make the best decision for you and your family.

 

 

Ashley F. Morgan, Esq. is a Virginia Bankruptcy Attorney. She helps individuals and business file bankruptcy in the northern Virginia area. Ashley understands bankruptcy should be your last option. She wants to help her clients review all potential options to avoid foreclosure to determine what is the best option in each person’s situation.