When you are in financial trouble, understanding the benefits of bankruptcy can make it possible for you to make a smart financial choice about whether bankruptcy is right for you. For most people, there is no greater financial trouble to be in than the threat of losing a house. Unfortunately, if you are not able to pay your mortgage, foreclosure is a very real possibility.
When you file for bankruptcy, an automatic stay goes into effect and foreclosure efforts have to stop. Over the term of the plan, bankruptcy enables you to bring your mortgage current. You may also be able to seek a modification during the bankruptcy process.
A bankruptcy is not going to reduce or eliminate debt owed to a primary mortgage lender. If you have a second (or third or subsequent) mortgage, however, it may be possible to use bankruptcy to save your home even if you cannot pay the full amount due.
If you have a second or subsequent mortgage on your home that you cannot pay, your second mortgage lender could foreclose on the home. If your second mortgage lender forces the sale of your home in a foreclosure, your first mortgage lender has a primary claim to the proceeds of the sale. The money from the sale of the home would go to pay back the first mortgage holder first. If anything was left over after that, then the money would go to the second mortgage lender.
For a lot of people, however, their home is not worth what they owe on it when their first, second, and other mortgages are combined. If your home is not worth enough to pay back both lenders, then your second mortgage lender may not actually have a secured loan, even though the mortgage documents claim to create one. For example, if you owe $200,000 on your first mortgage and $50,000 on a second mortgage but your home is worth just $150,000, then your first mortgage lender would get the entire proceeds from the sale of your house for $150,000. The second mortgage lender would get nothing.
If this is your situation and you file for bankruptcy, a process called lien stripping can result in the second mortgage debt being reclassified as unsecured debt. This means the bankruptcy court would essentially acknowledge the reality that the second mortgage lender does not have a security interest in your house.
The second mortgage lender wouldn’t be able to foreclose, and the unsecured debt from your second mortgage could be treated like any other unsecured debt in a Chapter 13 bankruptcy. It could be included in your bankruptcy repayment plan and you could keep your house even if you do not pay the balance off in full! A bankruptcy attorney can help determine if this is a possible option for you.