Considering a bankruptcy filing takes a lot of thought and could be a concern if you have a mortgage. And although bankruptcy offers protection to homeowners, it also has rules that may affect your mortgage. This could be in the short and long term.
Besides the effect on your current mortgage, there’s the danger of not being able to apply for another one. But can you keep your house, and what are your options after declaring bankruptcy?
What Happens When You Declare Bankruptcy?
Bankruptcy helps people reorganize or eliminate some debt. Once you file bankruptcy, an automatic stay goes into effect by a federal court order. This will give you breathing room by temporarily halting collection actions, including foreclosure.
This doesn’t mean you’re required to leave your home, and it doesn’t accelerate your mortgage, according to Rocket Mortgage. Your loan terms stay the same.
There are two types of bankruptcy you can declare: Chapter 7 and Chapter 13. To decide which one meets your circumstances, it is wise to contact an attorney.
Your Home Is Collateral for Your Mortgage
Your home serves as collateral, which means a mortgage is a type of secured debt. This means your lender has the right to foreclose if you stop making payments. Other debts, such as medical bills or credit cards, are unsecured debt. They aren’t tied to an asset.
So, since your mortgage is secured, bankruptcy doesn’t automatically eliminate the lender’s claim on it.
This distinction between secured and unsecured matters in bankruptcy.
Chapter 7 Bankruptcy
Chapter 7 bankruptcy eliminates certain unsecured debts, so you’ll have a financial reset. According to the Law Office of Joel R. Spivack, a U.S. trustee will assess and collect your property and sell it. Then the proceeds will be distributed to your creditors.
Your home may be protected through an exemption. Exemption is the amount of money you’re entitled to that the trustee can’t liquidate.
Exemptions Can Protect Property During Chapter 7 Bankruptcy
If your home is deemed exempt property, creditors can’t seize and sell it in order to satisfy debt during Chapter 7, according to Cornell Law School. However, the property exemption differs from state to state. And there are different levels. Property can be:
- Fully exempt—a trustee can’t liquidate.
- Partially exempt—depends on equity in the house and the amount of total exemption; the trustee may decide it’s beneficial to sell the property.
- Zero exemption—if there is no property exemption and the home has equity, the trustee can sell it.
According to Justia, there’s a chance you may be able to keep your home and preserve most of your equity in it by using the homestead exemption.
Homestead Exemption Covers Some Equity
In Chapter 7 and Chapter 13 bankruptcy, if the homestead exemption covers all your equity, it will prevent the trustee from selling your home.
The amount of equity the homestead exemption covers depends on the state where you live. There may be a limited amount of equity that is exempt.
Some states don’t have a homestead exemption, so you’ll need to use federal exemptions if they are an option. Many states let you choose which set of exemptions to use. However, you cannot choose exemptions from the state while using federal exemptions.
In some situations, you may have more equity in your home than the homestead exemption covers. When this happens, the trustee will sell the home. They will then pay the mortgage holder, since it is a secured creditor with priority.
Once the lender is paid, the trustee will reimburse you for the amount of the homestead exemption. The remaining funds will pay the unsecured debts.
Chapter 13 Bankruptcy
Chapter 13 helps people with a steady income catch up on overdue bills. In this case, you’ll work with a court to develop a repayment plan over three to five years, according to U.S. Courts.
With Chapter 13, you’ll have the opportunity to save your home from foreclosure. You can stop foreclosure proceedings and may be able to pay delinquent mortgage payments over time. However, you must still make all mortgage payments that come due during the Chapter 13 plan.
For unsecured debts, you will make payments to a chapter 13 trustee who will then distribute them to creditors. You won’t have direct contact with the creditors under Chapter 13 protection.
However, under Chapter 13, your monthly payments under the repayment plan will include the non-exempt equity in your home. If you have a lot of equity, your payments may be high. If this happens, you may not be able to meet the payments unless you have substantial income.
The trustee may be concerned that you can’t make the payments with your income and file an objection to the plan.
The court will then hold a hearing to confirm the plan, and if they reject it, you may need to sell the home, pay off some debts, and then file for bankruptcy.
Can You Qualify for a Mortgage After Bankruptcy?
Although it can be a challenge, it’s not impossible to qualify for a mortgage after bankruptcy.
According to Lending Tree, you’ll need to go through a waiting period before you can qualify. If you go through Chapter 7 bankruptcy, you’ll need to wait four years (two with extenuating circumstances) for a conventional mortgage. You’ll also need a credit score of 620 or higher with a minimum 3 percent down payment.
For chapter 13, a conventional mortgage waiting period is two years from the discharge date and four years from the dismissal date (two years with extenuating circumstances).
FHA Has Shorter Waiting Period
The Federal Housing Administration (FHA) has a shorter waiting period. According to the U.S. Department of Housing and Urban Development, a Chapter 7 bankruptcy doesn’t disqualify you from obtaining an FHA-insured mortgage.
At least two years must have elapsed since the date of discharge. And over the past two years, you must have reestablished good credit. If you haven’t established good credit, you must not have incurred new credit obligations.
Under Chapter 13, the FHA requires that at least 12 months of the payment period under the bankruptcy have elapsed. The lender must determine that during the most recent 12 months, your payment performance has been satisfactory. All payments must have been made on time.
You also must have received written permission from the court to apply for and receive a mortgage.
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