Making Sense of Bankruptcy: Choosing between Chapter 7 and Chapter 13 to Save Your Home
June 10, 2015
If you’re behind on your home mortgage, when would a Chapter 7 regular bankruptcy be enough vs. needing the benefits of a Chapter 13 plan?
Here’s the sentence that we’re explaining in today’s blog post:
If your home is threatened by foreclosure, Chapter 7 usually buys you relatively little time but maybe enough if you 1) can catch up on the mortgage arrearage after writing off your other debts, 2) can qualify for a mortgage modification, or 3) have decided to leave; otherwise Chapter 13 can usually buy you much more time and give other big advantages.
The filing of either kind of consumer bankruptcy stops a pending home foreclosure, or can prevent one from begin started. But whether you should file a Chapter 7 or Chapter 13 case depends on your goals with the home and your broader goals, and on how much help you need in reaching them.
Buying Some Time with Chapter 7
Filing a Chapter 7 case immediately imposes the “automatic stay” on your mortgage lender, and on all your other creditors. This is the federal law which freezes (“stays”) virtually all collection actions against you or your property, including a home foreclosure. And it prevents new collection actions as long as the “automatic stay is in effect. This stopping and preventing of foreclosures includes both non-judicial ones and those involving a lawsuit. What’s crucial is to file on time, because once the foreclosure has progressed beyond a certain point the “automatic stay” can no longer help, even if you are still occupying the home.
The other crucial timing aspect under Chapter 7 is that the “automatic stay” protection only lasts a short time, usually about three months or so. And the mortgage lender can even ask the bankruptcy court to cut short that protection. As a result filing a Chapter 7 case is primarily worth considering in the following three situations.
First, Catch up on the Mortgage Arrearage
Most people who file a Chapter 7 case gain some monthly cash flow because they no longer have to pay some of their debts. Consider the Chapter 7 option if you want to keep your home and after filing bankruptcy you will have enough cash flow to make both your regular mortgage payments plus enough extra to be able to catch up on the late payments within about a year.
Most mortgage lenders will consider having you to enter into what is often called a forbearance agreement, in which they agree to “forbear” from foreclosing as long as you resume and then consistently make the regular mortgage payment plus an agreed monthly amount to catch up. How long you have to catch up depends on each lender and your individual circumstances. Ask your attorney, who may have some experience with your lender.
Second, Qualify for a Mortgage Modification
You may have started a mortgage modification with your lender but time is running out before a pending foreclosure. Or you may not have been aware that you could qualify for a modification that would reduce your mortgage payment(s) and/or not require you to catch up on all or part of your missed payments, and want to apply. Filing a Chapter 7 case may give you enough time to finish or go through a mortgage modification process.
Third, You’ve Decided to Leave
If you’ve fully investigated your options and have decided that it’s best to surrender the house back to your lender, you may want to make the move in a less rushed, calmer way. If you only need another few weeks or months before you can move, a Chapter 7 bankruptcy filing would stop any immediate foreclosure and/or prevent one from being started for a while. The lender may even back off altogether during the three months or so while the bankruptcy case is active, or may be willing to agree upon a date for you to leave that will work with your schedule. The lender might even be willing to pay you to move by a date certain, in return for the lender saving time and money in not having to foreclose and/or evict you. And at worst, even if your lender is not so amenable you will likely have at least an extra few weeks—and more likely an extra few months—of rent-free housing.
Buying a Lot More Time with Chapter 13
Instead of buying a relatively short time, Chapter 13 can usually give you as much as five years to catch up on your back mortgage payments. If you are in foreclosure or anticipating that you will be soon, you could easily be tens of thousands of dollars behind on your mortgage. You may also be behind on property taxes and/or homeowner association assessments. You likely need as much time as possible to catch up on these. By stretching the repayment period as long as five years, this lets the monthly catch-up payment be that much lower, making keeping your home more feasible.
Other Big Chapter 13 Advantages
Beyond giving you more time to catch up, Chapter 13 gives you a flexible and powerful package of other benefits. Instead of being at the mercy of your mortgage lender about how the amount of time you will have to catch up, you are much more in control of that process. Very importantly, you are usually allowed to fit your mortgage obligations in with your other important creditors. This includes other creditors related to your home, such as property taxes, any homeowner association dues, and income tax liens on your home. And such home-related obligations can be taken care of while simultaneously satisfying other crucial creditors, such as a vehicle loan (including possibly reducing its payments through “cramdown”), and/or any child or spousal support arrearage.
Chapter 13 also may allow you to “strip” a second or third mortgage off your home’s title, so that you would no longer need to make that monthly payment. This could make the difference in your home being affordable. And this mortgage “strip” could reduce the debt on your home by tens of thousands of dollars and make you much closer to building equity in it.
Finally, a Chapter 13 case comes with a fair amount of flexibility during the period you’re in it. Your payment plan can usually be adjusted to reflect changes in your income and expenses, making more likely that you could keep your home in the long run. Because of this flexibility even if your motivation for keeping the home changes while you’re in the case—such as if you get a new job out of the area—you can change your mind and sell or surrender the home then, in a more financially protected way.