What Happens to a House After Bankruptcies?

Bankruptcy can significantly impact homeownership. For many, their home represents a substantial asset and a place of stability, making its fate a primary concern during bankruptcy proceedings. Understanding how bankruptcy laws interact with property rights is essential for homeowners considering this path. This article explores the various ways a home is treated in bankruptcy, from initial filing to potential retention or surrender.

How Bankruptcy Affects Home Ownership

Upon filing for bankruptcy, a debtor’s home becomes part of the “bankruptcy estate.” This estate broadly encompasses all legal or equitable interests in property held by the debtor. The bankruptcy trustee then assumes control over these assets to manage them for the benefit of creditors.

The treatment of a home in bankruptcy largely depends on the specific chapter filed. Chapter 7 bankruptcy involves the trustee gathering and selling nonexempt assets to pay creditors. In contrast, Chapter 13 bankruptcy is a reorganization process where debtors propose a repayment plan to creditors over a period of three to five years. Debtors typically retain all their property in Chapter 13, but they must pay an amount equal to the value of any nonexempt assets to their creditors through the repayment plan.

A significant immediate effect of filing for bankruptcy is the “automatic stay.” This immediately stops most collection activities, including foreclosure proceedings. The automatic stay provides temporary relief. However, a lender can ask the bankruptcy court to lift the automatic stay, which, if granted, would allow foreclosure proceedings to resume.

Options for Retaining Your Home

Homeowners seeking to retain their property during bankruptcy have several mechanisms to protect their equity and manage mortgage obligations. One primary tool is the homestead exemption, which allows debtors to protect a certain amount of equity in their primary residence from creditors. The specific exemption amount varies significantly by state, with some states offering unlimited protection and others imposing strict dollar limits. If a homeowner’s equity falls within the applicable homestead exemption, a Chapter 7 trustee typically cannot sell the home.

Another option for keeping a home, particularly in Chapter 7, is a reaffirmation agreement. This is a voluntary contract between the debtor and the mortgage lender to repay the mortgage debt, even though it would otherwise be discharged in bankruptcy. By entering into such an agreement, the debtor agrees to continue making payments under the original or modified loan terms, thereby preserving their personal liability for the debt and retaining the property. However, if a debtor defaults on a reaffirmed debt, the creditor can pursue collection efforts, including foreclosure and potentially a deficiency judgment.

Chapter 13 allows homeowners who are behind on mortgage payments to “cure” mortgage arrears by including the overdue amounts in a court-approved repayment plan. The plan typically spans three to five years, during which the debtor makes regular mortgage payments along with additional payments to catch up on the missed amounts. This process can effectively halt foreclosure. Furthermore, in Chapter 13, it may be possible to “strip” junior liens if the value of the home is less than the outstanding balance of the first mortgage. If successfully stripped, these junior liens are reclassified as unsecured debt and are often paid only a small percentage of what is owed through the Chapter 13 plan.

When a Home is Not Retained

Sometimes, a debtor may choose or be compelled to surrender their home during bankruptcy. Surrendering the property means the debtor voluntarily gives up ownership to the mortgage lender. In such cases, the personal liability for the mortgage debt is typically discharged through the bankruptcy process. This can provide financial relief, particularly if the home is “underwater,” meaning the outstanding mortgage balance exceeds the property’s market value.

In a Chapter 7 bankruptcy, if there is non-exempt equity in the home, the bankruptcy trustee has a duty to liquidate this asset. The trustee sells the home, uses the proceeds to pay the mortgage holder, reimburses the debtor for any applicable homestead exemption, and then distributes the remaining funds to unsecured creditors.

After a home is surrendered and the bankruptcy discharge is granted, the mortgage lender can proceed with foreclosure. While bankruptcy discharges the debtor’s personal responsibility for the mortgage debt, it does not eliminate the lender’s lien on the property. Therefore, the lender retains the right to take possession of the home through foreclosure to satisfy the outstanding lien. The time it takes for a foreclosure to finalize after bankruptcy can vary, allowing the former homeowner to remain in the property for several months without making payments.