What Happens to a Mortgage When Filing Bankruptcy?

Filing for bankruptcy offers a structured path to financial relief, but it significantly impacts existing financial obligations, including mortgage debt. The specific impact on a home mortgage largely depends on the type of bankruptcy filed and the debtor’s objectives regarding their property. Understanding these distinctions is important for homeowners considering this legal process. The bankruptcy system provides different approaches to debt resolution, each with unique effects on secured debts like mortgages.

Initial Impact of Filing on Mortgage Debt

When a bankruptcy petition is filed, the Automatic Stay immediately comes into effect. This legal injunction, codified under 11 U.S.C. § 362, automatically halts most collection actions against the debtor and their property, including mortgage foreclosure proceedings and collection calls.

The Automatic Stay provides debtors a temporary reprieve from creditor pressure, allowing them a “breathing spell” to reorganize their financial affairs under court supervision. It also ensures an orderly process for the bankruptcy court to manage assets. While the stay offers immediate protection, it is not a permanent solution for mortgage issues.

Mortgage lenders can petition the court for “relief from stay” under 11 U.S.C. § 362 if certain conditions are met. This relief might be granted if the debtor lacks adequate protection for the creditor’s interest, if there is no equity in the property, or if the bankruptcy case was not filed in good faith. If granted, the lender may resume foreclosure or other collection actions.

While the Automatic Stay pauses collection efforts, it does not eliminate the underlying mortgage lien on the property. The lien, which is the lender’s legal claim to the property as collateral, remains in place. This allows the lender to eventually pursue the property if the debt is not addressed, even after the stay is lifted or the bankruptcy case concludes.

Handling Your Mortgage in Chapter 7 Bankruptcy

Chapter 7 bankruptcy, often referred to as liquidation bankruptcy, discharges many unsecured debts. While it can discharge a debtor’s personal responsibility for mortgage debt, it does not eliminate the mortgage lien on the property itself. The lender’s claim against the property persists even if the individual is no longer personally liable.

Homeowners in Chapter 7 have distinct options concerning their mortgage. One option is to surrender the property, which involves relinquishing it to the lender. In this scenario, the debtor’s personal liability for the mortgage debt is discharged, and the lender proceeds with repossession or foreclosure.

Another option for debtors wishing to keep their home is a reaffirmation agreement. This voluntary agreement with the lender continues mortgage payments, waiving the bankruptcy discharge for that debt. Governed by 11 U.S.C. § 524, a reaffirmation agreement reinstates the debtor’s personal liability. It must be filed with the court before discharge and reviewed to ensure it does not impose undue hardship.

A less common option for mortgages in Chapter 7 is redemption, outlined in 11 U.S.C. § 722. Redemption allows a debtor to pay the lender the property’s current market value in a lump sum, thereby releasing the lien. This option is more practical for personal property like vehicles that are worth less than the outstanding loan, rather than for real estate, due to the requirement of a single, large payment.

Regardless of the chosen path, if a debtor intends to keep their home after a Chapter 7 filing, they must continue to make all mortgage payments. Even if personal liability is discharged, the lender retains the lien. If payments cease, the lender can still initiate foreclosure proceedings to reclaim the home.

Handling Your Mortgage in Chapter 13 Bankruptcy

Chapter 13 bankruptcy provides a structured repayment plan, enabling debtors to reorganize finances over three to five years. This bankruptcy type is useful for homeowners behind on mortgage payments who wish to retain their homes. A key benefit of Chapter 13 is its ability to stop foreclosure proceedings and allow debtors to catch up on missed mortgage payments.

Within the Chapter 13 repayment plan, debtors propose a schedule to repay mortgage arrears over the plan’s life. This helps debtors manage past-due amounts without immediate foreclosure. Debtors are also required to continue making regular, ongoing mortgage payments directly to the lender outside of the plan.

A strategy available in Chapter 13 is “lien stripping,” governed by 11 U.S.C. § 506. This applies to wholly unsecured junior mortgages, such as a second mortgage or home equity line of credit, when the home’s value is less than the first mortgage balance. If the junior lien is completely underwater, it can be reclassified as unsecured debt within the Chapter 13 plan.

Once reclassified, this unsecured debt is treated similarly to other unsecured debts in the plan, often resulting in only a fraction being repaid. Upon successful completion of the Chapter 13 plan, this stripped junior lien is discharged, removing the lien from the property. This process does not apply to first mortgages on a debtor’s primary residence.

Confirmation of a Chapter 13 plan provides ongoing protection from foreclosure, as long as the debtor adheres to its terms. Upon successful completion of the plan, the debtor receives a discharge, including cured arrears and potential discharge of stripped junior liens. The original first mortgage, if not stripped, continues as a valid lien, requiring continued payments.