The Treatment of Your Primary Mortgage Lender in a Bankruptcy Proceeding

What Happens to Your Primary Residence in Bankruptcy?

If you are struggling to pay your debts, one of which is a substantial mortgage, you may have considered bankruptcy, but worry about what will happen to your home. Can you discharge the debt on your house? Will you be forced to give up your property?

One of the basic rules of bankruptcy is that you generally cannot discharge the debt on secured property and keep the property. There are, however, some exceptions.

If you have a mortgage or land contract on your principal residence, it will be considered secured debt. When you file for bankruptcy protection, you will be entitled to the automatic stay, which prohibits your creditors, including your mortgage company, from attempting to collect a debt other than through the bankruptcy proceeding. However, the circumstances under which you will be allowed to eliminate the debt on the home and stay there are extremely limited.

Keeping Your Home in a Chapter 13 Proceeding

Most debtors use a Chapter 13 filing to keep a primary residence. With a Chapter 13 petition, you enter into new payment arrangements with creditors, including your mortgage lender. Typically, the repayment period lasts three to five years. During that time, you often pay a smaller amount, and don’t have to face calls, letters or other attempts to collect on the mortgage. However, when the Chapter 13 period is over (which will have allowed you to fully pay off many of your debts), any amount still owing on your home is still due. Ideally, because you no longer have many of your other debts, you will have the additional cash flow to make full payments. You may even be able to refinance or renegotiate the terms of your mortgage.

Keeping Your Home in a Chapter 7 Proceeding

In a Chapter 7 filing, you get to discharge debts in exchange for the sale of assets. Both state and federal bankruptcy laws allow you to keep a certain amount of your property, known as your “exemption amount.” There are generally only two ways that you can file for Chapter 7 bankruptcy protection and keep your home: you own your home outright and the value of your home is falls within the exemption amount, or you have no equity in your home.

If you own your home free and clear, and its value is less than set forth in the state or federal exemptions, the trustee cannot touch it. On the other hand, if you have little or no equity in your home, there’s no incentive for the trustee to try to sell it. The trustee would be required to pay off the mortgage first, and you are then entitled to your exemption amount before any other creditors receive anything.