While Dickensian debtors' prisons are a thing of the past, legal proceedings still exist to deal with debt problems. These proceedings include bankruptcy and foreclosure. Both are symptoms that a borrower is over his head in debt. Whereas debtors usually elect to undergo bankruptcy, the lender or other lien holder instigates a foreclosure proceeding. Sometimes people undergo both simultaneously.
Foreclosure occurs when the mortgagee repossesses property used as collateral for a loan. In most cases, this is real property. In some instances, however, it can also be a big-ticket item such as a boat. If the owner defaults on the mortgage, the bank can foreclose and repossess the property.
Depending upon jurisdiction, a foreclosure can be judicial or non-judicial. While all states allow judicial proceedings, many also allow non-judicial proceedings if the mortgage includes "power of sale" language that allows the mortgagee to sell the property. The owner often has a right of redemption that allows him to stop the proceedings by paying the amount owed by a specific date.
Bankruptcy proceedings provide relief to a debtor -- either by establishing a repayment plan or eliminating the debt altogether. A bankruptcy proceeding occurs in a federal bankruptcy court. While the burden of debt is less onerous after bankruptcy, it can remain a blight on your credit report for up to 10 years.
Types of Bankruptcy
Most individuals file for either chapter 7 or chapter 13 bankruptcy. Whereas chapter 7 eliminates the debt, chapter 13 permits restructuring of the debt. Under Chapter 7, the debtor discloses all her assets so that the court can determine whether the property can be sold to pay down the debt. Assets such as household furnishings and clothing are categorized as exempt and cannot be used to pay the debt. Other property, such as a home or car, is also exempt up to a certain amount, which can vary depending on the state in which the debtor files for bankruptcy. Under chapter 13, the debt is restructured so that the debtor can pay it down -- usually within 3 to 5 years. Because income is necessary to pay down the debt, debtors who are working or have other sources of income file for chapter 13. Regardless of which form is pursued, legal obligations, such as taxes and child support, cannot be discharged in bankruptcy proceedings.
It is important to understand your legal rights and obligations if a bank threatens foreclosure or if you wish to declare bankruptcy. Both can involve the loss of rights if you do not proceed carefully. For example, you can lose the right to file for bankruptcy if you had bankruptcy action dismissed in the previous 180 days because you failed to comply with court orders or dismissed the proceeding to avoid a creditor's attempt to recapture property.