Bankruptcy is a legal proceeding that discharges or restructures debts. Most homeowners either go through Chapter 7 or Chapter 13 bankruptcy proceedings. If you file Chapter 7, the court appoints a trustee who gathers your assets and uses them to pay off your creditors. Many assets qualify as exempt and cannot be used to pay creditors. Whether or not an asset is exempt can vary from state to state. Chapter 13 bankruptcy works differently. If you file Chapter 13, your debt will be restructured so that you can pay it off over a 3- to 5-year period.
Temporarily Halting Foreclosure
Filing for bankruptcy temporarily halts any foreclosure action. After you file for bankruptcy, the judge issues an order for relief telling your creditors that they must stop collection efforts for the duration of the bankruptcy proceeding. This order for relief is known as an automatic stay. Although the lender can contest the stay, you still have bought yourself some time to remain in your home. The automatic stay provides no relief if the bank has already held the foreclosure sale. If the title has already passed to the new buyer, you must leave your home. The state of Oregon requires that you move out of your home within 10 days of a foreclosure sale. Other states impose different requirements.
Benefits of Chapter 13
The bank might never foreclose your home if you file Chapter 13 bankruptcy. This form of bankruptcy allows you to restructure the past-due mortgage payments and pay it over an extended period of time. However, you must still pay all future mortgage payments as they come due.
Foreclosure and Chapter 7
The likelihood of a positive outcome is less certain if you file Chapter 7. Depending upon where you live, it is possible to lose your home in a bankruptcy proceeding, even if the mortgage debt is forgiven. This outcome is possible because most mortgages include a promissory note and a lien. The promissory notice is your promise to the lender to pay the bank. The lien is your agreement to use the property as collateral if you default on your debt. While a Chapter 7 bankruptcy forgives your debt, it does not address the lien. If you file Chapter 7, foreclosure proceedings can run their usual course after you are declared bankrupt.
Both states and federal law provide for homestead exemptions that protect at least some of the equity you have in your home. For example, the laws of Texas, Iowa and several other farm states protect all of your equity. Other states protect a lesser amount. Federal law provides weak protection: it exempts only $22,975 of the equity. Double-check with your state as these amounts often change.
Foreclosure may take place after the bankruptcy. Different states and lenders have different foreclosure proceedings that determine the timeline. All states allow judicial foreclosure. Since judicial foreclosure requires the involvement of the court, it tends to be a slower process. Many states also allow statutory foreclosure. If your mortgage contains a power of sale clause and you live in a state that allows non-judicial foreclosure, your lender can foreclose without the involvement of the court. Such a foreclosure takes approximately 120 days in California, 75 to 90 days in Massachusetts and 180 to 200 days in Florida.