What Happens to My Mortgage if I File Bankruptcy?

Bankruptcy offers a legal path to manage overwhelming debt and achieve a fresh start. When a mortgage is involved, the implications of filing for bankruptcy are significant and vary by bankruptcy type and homeowner objectives. A mortgage is a secured debt, tied directly to the home. If loan payments are not met, the lender can take possession of the property.

Initial Impact on Your Mortgage

Upon filing a bankruptcy petition, the “automatic stay” immediately goes into effect. This court order temporarily halts most collection activities by creditors, including mortgage foreclosure proceedings. Mortgage servicers are prohibited from contacting the debtor for payment or taking action against the property while the stay is active.

The automatic stay provides debtors with a pause, preventing individual creditor actions and allowing the bankruptcy court to oversee the process. This temporary injunction stops repossessions, wage garnishments, and lawsuits. The automatic stay is not a permanent solution; it does not eliminate the underlying mortgage debt or remove the lender’s lien. It gives the debtor and court time to address the financial situation.

Mortgage in Chapter 7 Bankruptcy

When a homeowner files for Chapter 7 bankruptcy, their personal liability for the mortgage debt is typically discharged. This means the borrower is no longer legally obligated to repay the loan. However, the lender’s lien on the property generally remains in place, allowing the lender to foreclose if payments are not made. Debtors must decide how to handle their secured debts, including their mortgage, by filing a Statement of Intentions with the court.

One option for homeowners wishing to keep their property is to enter into a reaffirmation agreement. This is a contract between the debtor and the mortgage lender, agreeing to continue making payments on the loan. Reaffirming the debt means that personal liability for the mortgage is not discharged, and the debtor remains responsible for the loan. The agreement must be filed with the court, and in some cases, court approval is required, particularly if the debtor’s budget indicates they cannot afford the payments.

Alternatively, a homeowner may choose to surrender the property. This discharges the debtor’s personal liability for the mortgage debt. Surrendering the property means the homeowner will not be responsible for any deficiency balance if the home sells for less than the outstanding mortgage amount. This option is often chosen when the homeowner can no longer afford the payments or the home’s value is less than the amount owed.

A less common option in Chapter 7 is redemption, which allows the debtor to keep the property by paying the lender its current market value in a lump sum. This option is typically only feasible if the debtor has access to a significant amount of cash and the property’s market value is less than the loan balance. Redemption is generally limited to personal property rather than real estate due to the financial outlay.

Mortgage in Chapter 13 Bankruptcy

Chapter 13 bankruptcy allows individuals with regular income to keep their home by proposing a repayment plan, typically spanning three to five years. A primary benefit of Chapter 13 for homeowners is its ability to address mortgage arrears.

Under a Chapter 13 plan, the homeowner can “cure” the default by spreading delinquent mortgage payments over the plan’s life. The debtor makes regular monthly mortgage payments outside the plan, plus separate payments through the plan to catch up on missed amounts. The plan must show the debtor has sufficient income for both ongoing payments and arrears. If the debtor fails to make ongoing payments, the automatic stay may be lifted, allowing foreclosure.

Chapter 13 also offers solutions for other property liens, such as second mortgages or home equity lines of credit. If the first mortgage’s balance exceeds the home’s current value, junior liens might be “stripped off” or reclassified as unsecured debt. This process, known as lien stripping, only occurs in Chapter 13 and converts the debt into an unsecured claim that may be discharged at the plan’s end.

Long-Term Mortgage Obligations After Bankruptcy

After a bankruptcy case concludes, the status of the mortgage and ongoing obligations are important considerations. While a bankruptcy discharge may eliminate a debtor’s personal liability for the mortgage debt, the mortgage lien on the property generally persists. This means the lender retains a legal claim against the property itself.

To keep the home, the homeowner must continue to make regular mortgage payments, regardless of whether personal liability was discharged or reaffirmed. If payments cease, the lender can still enforce its lien through foreclosure. The bankruptcy filing will appear on a credit report for typically seven to ten years, which can affect the ability to obtain new credit or refinance a mortgage in the short term. However, consistent, timely payments on any remaining or new credit obligations can gradually help in rebuilding creditworthiness over time.