Should I File For Bankruptcy Before Or After Foreclosure?
Many people living in Utah fall behind on their mortgage payments. Some lenders and mortgage companies may be willing to work out deals with homeowners, such as a short sale or loan modification. Most lenders are not. Here’s how bankruptcy can help when lenders begin the foreclosure process. When someone falls significantly behind on mortgage payments, a lender will most likely begin the foreclosure process, as set out in the mortgage contract. The foreclosure process involves the creditor repossessing and usually selling the house at a public auction. The proceeds from that auction are used to repay the mortgage and any legal costs.
The foreclosure process takes time. Most creditors do not begin foreclosing until the homeowner is two to three months behind on their mortgage payments. This gives the homeowner some time to consider alternatives to foreclosure, such as loan forbearance, short sale, or deed in lieu of foreclosure. Should all of these alternatives fail (or not be ideal), bankruptcy may help in several different ways. So would contacting a qualified foreclosure attorney for a consultation.
Foreclosure vs. Bankruptcy
You may decide to declare bankruptcy or to go through foreclosure depending on a few factors, including your income, debts, and living expenses. The main difference, of course, is that through bankruptcy, you may be able to keep your home.
Here are some other differences between the two:
1. Who Initiates the Case
In cases of bankruptcy, you will be the one starting the process by filing a bankruptcy petition. In foreclosure, the lender is the one who initiates the proceeding to repossess and sell the property.
2. What Happens After the Case?
There is a chance you can keep your home after bankruptcy, but this isn’t always the case. If you don’t have the income to continue paying your mortgage after bankruptcy, you may need to let go of your home.
So why file bankruptcy instead of just accepting the foreclosure?
The main difference between the two is what happens after the sale of the property. In a foreclosure, there is a possibility that you will still owe money to the creditor after the sale if the proceeds of the sale don’t cover the debt. In a bankruptcy, however, all debts will be discharged after the case is closed.
3. Who Controls the Property?
Once a foreclosure proceeding is initiated, your creditor will have control over the home. But in a bankruptcy, you may be able to retain control of the property until the bankruptcy case is finalized through the “automatic stay” order.
How to Delay Foreclosure With an Automatic Stay
One of the most commonly asked questions is “can filing bankruptcy stop a foreclosure?” If you are facing foreclosure, bankruptcy can become a tool to help you keep your house. Once you file bankruptcy, either Chapter 13 or Chapter 7, the court automatically issues an Order for Relief. This order grants you an “automatic stay” that directs your creditors to immediately cease their collection attempts, no matter what. So, if a foreclosure sale has been scheduled for your home, it will be postponed, by law, until the bankruptcy is finalized. This usually takes about three to four months.
There are two exceptions to this buying-time rule:
1. If the lender files a motion to lift the stay: The lender can file a motion to lift the stay, which asks permission from the bankruptcy court to continue with the foreclosure sale. If this is granted, you may not receive the extra three to four months of time. However, bankruptcy normally still postpones the sale by about two months or more, or even longer if the lender does not act fast in filing the motion to lift the stay.
2. If the foreclosure notice has already been filed: Most states have laws that require lenders to give homeowners a certain amount of notice before selling their property. A bankruptcy’s automatic stay will not stop the clock on this advance notice.
For instance, Utah law requires a lender to give the homeowner at least three months’ notice before selling the home. If a Utah resident receives this three-month notice and then files for bankruptcy two months later, the three-month period would have passed after being in bankruptcy for only one month. As a result, the lender could file a motion to lift the stay and ask the court’s permission to schedule the foreclosure.
How to Use Chapter 13 Bankruptcy to Help You
Chapter 13 bankruptcy allows you to set up a repayment plan to pay off the past-due payments, or “arrearage.” You can propose the length of time for repayment, but keep in mind that you’ll need sufficient income to pay both your past-due payments and your current mortgage payments at the same time. So long as you make all of the required payments for the length of the repayment plan, you will avoid foreclosure and be able to stay in your home.
2nd and 3rd mortgage payments: Chapter 13 can also help eliminate payments on second or third mortgages. Typically, Chapter 13 entitles bankruptcy courts to re-categorize second and third mortgages as unsecured debt. Under Chapter 13, unsecured debt takes last priority and usually does not have to be paid back. This re-categorizing process is possible if your first mortgage is secured by the entire value of your home since this means there is no remaining equity in your home to secure the second and third mortgages.
How to Use Chapter 7 Bankruptcy to Help You
Chapter 7 bankruptcy also cancels all the debt secured by the home, including mortgages and home equity loans. Furthermore, Chapter 7 goes a step further. Chapter 7 also forgives the homeowner for tax liability for losses the mortgage or home-improvement lender incurs as a result of the homeowner’s default. This law initially applied to the years 2007-2010. But it has been extended five times and now applies to debts forgiven in the years between 2007 to 2020.
However, this tax law does not cancel the homeowner’s tax liability for the lender’s losses at foreclosure if:
• The loan is not a mortgage or was not used for home improvements (like a loan used to pay for a vacation or automobile).
• The mortgage or home equity loan is secured by property other than your principal residence (like a vacation home or rental property).
Cautionary Notes About Chapter 7
You could still lose your home. All of this debt and tax liability forgiveness is great, but note that Chapter 7 will not keep you from losing your home.
Chapter 7 forgives your debt, and that is all it does. When you enter into a mortgage, you are agreeing to use your home as a type of collateral in case you default on your payments.
Chapter 13 enables you to pause action on that lien while you catch up on your payments; hence, you may save your home. Chapter 7 forgives your debt, but it will not lift the lien, and hence will not lift the foreclosure on your home. Therefore, you can still lose your home.
You could lose other valuables: Because the courts typically want to make the creditors whole again from their loss, the bankruptcy trustee may award money from the sale of certain other valuables of yours to the creditors. For example, if you have a valuable wedding ring that’s value exceeds the dollar amount you are allowed to keep during bankruptcy under the jewelry exemption, you could lose your wedding ring.
You may not be eligible: The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 provides that anyone whose average gross income for the six-month period before the bankruptcy filing exceeds the state median income for the same sized household is ineligible for Chapter 7 bankruptcy. Additionally, if your income is sufficient enough for you to pay your living expenses and fund a reasonable Chapter 13 repayment plan, you are also ineligible for Chapter 7.
How Bankruptcy Will Affect Your Credit
Although bankruptcy and foreclosure are both damaging to your credit, sometimes filing bankruptcy can be a wise choice when trying to rebuild credit. A foreclosure not only damages your credit score for years, but you are still left with the mortgage debt. Most mortgage creditors will not consider you for future mortgages if you have a foreclosure on your credit history.
In contrast, bankruptcy lets you start fresh. It still damages your credit, but because you are debt-free, you begin rebuilding good credit sooner. Although bankruptcy has a few negative consequences, and may not save you from losing your home, it can be the best option in starting fresh with no debt, getting back on your feet, and saving money.
Worst Case Scenario: Losing the House, but Also the Debt
Sometimes bankruptcy can’t prevent the loss of your home, so you may start to think that a bankruptcy filing is pointless. There are other benefits to filing for bankruptcy besides the interplay between bankruptcy and foreclosure, however. Even if you can’t keep your home, bankruptcy can help to shovel out from under mortgage debts and tax liability. This is an important first step towards getting back on your feet. Bankruptcy can also help you to put away money for the tough times ahead.
Filing Bankruptcy to Avoid a Deficiency Judgment
If your lender comes after you for the deficiency, and you later file for bankruptcy, bankruptcy will discharge (eliminate) the deficiency debt. But for many people, it makes more sense to file bankruptcy before foreclosure to discharge the mortgage debt preemptively. Then you don’t have to worry about the possibility of a deficiency judgment. This tactic can provide peace of mind because once the mortgage debt is discharged, you know you won’t have to face a lender’s lawsuit to recover the deficiency after the foreclosure. Of course, if your state’s laws prevent the lender from getting a deficiency judgment, you don’t need to take this approach.
Filing Bankruptcy to Avoid Tax Liability for Forgiven Debt
Another reason to file bankruptcy before the foreclosure is because if your lender forecloses and cancels the deficiency debt rather than seeks a deficiency judgment, you might have to include the canceled amount as income on your tax return. If that happens, you generally must pay tax on that forgiven debt unless you qualify for an exception or exclusion such as:
The Mortgage Debt Relief Act of 2007 (Qualified Principal Residence Indebtedness Exclusion)
The Mortgage Debt Relief Act of 2007 and its various extensions exclude forgiven debt from your taxable income if the loan:
• was taken out to buy, build, or substantially improve your principal residence (or refinanced a mortgage taken out to buy, build, or substantially improve your principal residence), and
• is secured by your principal residence.
This “Qualified Principal Residence Indebtedness (QPRI) Exclusion” applies to debt forgiven in calendar years 2007 through 2025. The exclusion can also apply to debts forgiven as the result of a written agreement entered into before January 1, 2026, even if the actual discharge happens later. If your forgiven mortgage debt qualifies, as of December 31, 2020, you can exclude up to $750,000 ($375,000 if married and filing separately). Before this date, taxpayers could exclude $2 million ($1 million if you’re married and filing separately).
The Insolvency Exception
If you were insolvent when the debt was canceled, some or all of the debt might not be taxable to you. You’re considered insolvent if your total liabilities (debts) are more than the fair market value of your total assets.
Bankruptcy Cancels Other Mortgage Debt
If you have any other mortgage debt, like a second mortgage or a HELOC, it could be wise to file bankruptcy before the foreclosure to wipe out your personal liability for those debts. When the first mortgage lender eventually forecloses, any junior mortgage lenders (second mortgages and HELOCs, for example) will also be foreclosed and lose their security interest in the real estate. Generally, if a junior mortgage lender has been sold-out in this manner, that junior mortgage lender could potentially sue you personally to collect the debt. But a bankruptcy will eliminate any debt secured by a second mortgage or a HELOC, and you can avoid future lawsuits from these lenders.
Bankruptcy Buys You Time in the Property by Delaying Foreclosure
If you file for bankruptcy before your home is sold at a foreclosure sale, you’ll get more time to live in the home. When you file bankruptcy, an “automatic stay” goes into effect. The stay acts as an injunction, or bar, against any attempts by creditors to collect debts or enforce liens, including taking any action related to a pending foreclosure.Because the automatic stay prevents the foreclosure case from moving forward, you get some extra time in the home. The lender does have the right to ask the bankruptcy court to lift the automatic stay, which would allow it to continue with the foreclosure, but this process will still take some time. In the meantime, you get to remain in the home.
You Can Save Money During the Foreclosure Delay
You can live in your home without making any mortgage payments during the bankruptcy—at least until the lender obtains relief from the stay and completes the foreclosure. Or the lender might forgo this right and simply wait for the bankruptcy case to conclude before continuing with the foreclosure. Either way, you’ll probably get a few extra months to live in the home without making payments, which would allow you to build up your savings. For instance, if your mortgage payment is $1,000 a month, you could end up saving several thousand dollars by staying in the home and not making payments during this time.
Facing Foreclosure? Have a Local Attorney Review Your Legal Options
If you’re facing a foreclosure and concerned about your financial future, remember that a bankruptcy filing may help you keep your home or at least soften the blow. You can learn more about your options by meeting with Ascent Law Firm attorney, who will understand your financial needs and work to make the process as painless as possible. Find a local bankruptcy attorney today.
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It’s not a matter of if, it’s a matter of when. Legal problems come to everyone. Whether it’s your son who gets in a car wreck, your uncle who loses his job and needs to file for bankruptcy, your sister’s brother who’s getting divorced, or a grandparent that passes away without a will -all of us have legal issues and questions that arise. So when you have a law question, call Ascent Law for your free consultation (801) 676-5506. We want to help you!
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