Bankruptcy-When To Use It and Not

One of the biggest decisions homeowners have to make when they fall behind on their mortgage payment is whether or not to file for bankruptcy. There are many factors that go into this decision. When making this decision, do not be intimidated or bullied into bankruptcy. Just because the borrower receives a notice that the foreclosure process has started, does not mean that a foreclosure sale is coming soon. Especially in judicial states, this process could take years. Unfortunately, many borrowers panic when getting such a notice and run to an attorney. The attorney then immediately files a bankruptcy petition, even though it is entirely unnecessary, costly and counterproductive. There may be less costly and better options such as a loan modification or a short sale. Keep in mind that there are two types of bankruptcy, Chapter 7 or a Chapter 13. Let us look at both options.

Chapter 7 is what is known as a complete liquidation, where the bankruptcy trustee will sell all of the debtors’ property, with some exemptions. Every state has different exemptions and it is important to know what they are. Obviously the most important asset is the house. If the mortgage is equal to or greater than the value of the house, the trustee will have no interest in the home and will just allow the lender to continue with the foreclosure action. In this situation, a Chapter 7 is useless. It may delay the sale for a while, but it will not save the home.

bankruptcyIf there is equity in the house, in other words, the house is worth more than the mortgage balance, the trustee may decide to sell the house. After paying off the lender, the trustee can use any money left over to pay other creditors of the homeowner. Again, this does not help the borrower keep the home. It should be pointed out that there are situations when a Chapter 7 can help borrowers after the house is gone. It can wipe out debts, but it cannot save the home.

Chapter 13 involves a payment plan. The borrower can keep the home as long as the payment plan is approved and the trustee believes that the homeowner can afford the payments. To simplify matters, what usually happens is that the borrower must continue to make the mortgage payments and pay arrears for any payments missed to the trustee. The arrears can be spread out for up to 5 years. The problem with this is clear. The borrower could not afford to make the payments in the first place and now must not only continue to make those affordable payments, but make additional payments to the trustee. A much better option is a loan modification.

There are circumstances where a Chapter 13 is the only option to save the home. In the following situations it is assumed that whatever financial hardship caused the borrower to miss the payments no longer exists. For example, the homeowner lost a job but now has found a new one. Someone in the household was not working and is going to work. Even in these situations, a loan modification is a better options but sometimes it is not possible.

The most common scenario is when the lender refuses to do a loan modification. One reason is that there is too much equity in the property. For example, suppose the property is worth $300,000 and the mortgage balance is $150,000. The bank knows that if it foreclosed, it will get all its money. Why take the risk on loan modification? The Chapter 13 forces the lender to work with the homeowner and as long the plan is affordable, they cannot foreclose. The second circumstance is when the lender has a policy of no modifications. This usually happens when the mortgagor is a small bank or a private lender. Again, a Chapter 13 will prevent the foreclosure as long as the homeowner can afford the plan.

As can be seen, bankruptcy is usually not the solution to save the home. Even if the bankruptcy process has been started, it is very possible to obtain a loan modification and take the mortgage out of the bankruptcy. D.G. Weber Law Associates has all the tools to help the borrower including loan modifications, short sales and bankruptcy. We will choose the option that is best for our clients.


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