How Does Bankruptcy Affect Your House?

Filing for bankruptcy significantly influences a homeowner’s primary residence. This legal process offers different outcomes, depending on the type of bankruptcy chosen and the individual’s financial situation. The impact on a home is not uniform, affecting equity, mortgage obligations, and potential foreclosure proceedings.

Bankruptcy Types and Your Home’s Fate

Two types of consumer bankruptcy, Chapter 7 and Chapter 13, treat a homeowner’s primary residence differently. Chapter 7, often called liquidation bankruptcy, involves a trustee potentially selling a debtor’s non-exempt assets to repay creditors. If a home has significant equity not protected by an exemption, the trustee may sell the property to distribute proceeds.

If the home’s equity is fully protected by an exemption, the debtor can keep the property in a Chapter 7 filing. Chapter 13, known as reorganization bankruptcy, allows debtors to retain their assets, including their home, while repaying debts through a court-approved payment plan. This plan typically spans three to five years, providing a structured approach to manage financial obligations. Debtors in Chapter 13 often use this plan to catch up on mortgage arrearages and maintain ongoing payments.

Protecting Home Equity with Exemptions

Exemptions are legal provisions that allow individuals filing for bankruptcy to protect certain assets from being sold by a trustee to pay creditors. The homestead exemption is particularly relevant for homeowners, as it shields a portion of their home’s equity. The amount of equity protected by the homestead exemption varies significantly based on jurisdiction, with some areas offering more generous protections than others.

Homeowners typically use either federal exemptions or state exemptions, but generally cannot combine elements from both systems. To qualify for a state’s homestead exemption, individuals often must have resided in the state for a specified period, such as 730 days, and purchased the home at least 40 months before filing for bankruptcy. If a home’s equity exceeds the applicable exemption amount in a Chapter 7 case, the non-exempt portion may be subject to sale by the bankruptcy trustee to satisfy creditor claims. In a Chapter 13 case, the value of any non-exempt equity may influence the amount that must be repaid to creditors through the repayment plan.

Handling Your Mortgage in Bankruptcy

A mortgage is a secured debt, tied to the property through a lien, allowing the lender to reclaim the home if payments are not met. In a Chapter 7 bankruptcy, while the personal obligation to repay the mortgage debt may be discharged, the lien on the property remains. This means the lender can still proceed with foreclosure if payments are not made, even after the bankruptcy case concludes. Debtors in Chapter 7 wishing to keep their home may enter into a reaffirmation agreement, which restores their personal liability for the debt but allows them to continue making payments and retain the property.

Chapter 13 bankruptcy provides a structured way to manage mortgage debt, especially for those behind on payments. The repayment plan can incorporate mortgage arrearages, allowing debtors to catch up on past-due amounts over the 3-5 year plan duration. Maintaining regular mortgage payments alongside the plan payments is generally required. Additionally, Chapter 13 may permit “lien stripping” for junior liens, such as second mortgages or home equity lines of credit (HELOCs), if the home’s value is less than the balance of the first mortgage. This process reclassifies the junior lien as an unsecured debt, which may be partially or entirely discharged upon successful completion of the repayment plan.

Impact on Foreclosure Proceedings

Filing for bankruptcy immediately triggers an “automatic stay,” which acts as a legal injunction that temporarily halts most collection actions, including foreclosure proceedings. This provides a period of relief, stopping creditors from continuing efforts to seize property. While the automatic stay offers immediate protection, its duration and effectiveness vary depending on the bankruptcy chapter.

In Chapter 7, the automatic stay typically lasts for a few months until the case is discharged or closed, providing temporary breathing room before a foreclosure can resume. Since Chapter 7 does not address ongoing mortgage payments or arrearages, the lender can request the court to lift the stay to continue with foreclosure once the bankruptcy concludes or if the debtor fails to make post-filing payments. Chapter 13 uses the automatic stay to allow homeowners to propose a repayment plan to cure mortgage defaults over an extended period. If the debtor adheres to the Chapter 13 plan, the automatic stay can provide long-term protection against foreclosure, allowing them to keep their home.