What Happens When a Bank Charges Off Your HELOC After a Chapter 7 Discharge?

By Tom Streissguth

If you file for a chapter 7 bankruptcy, you are asking a federal court to protect you from collection actions and lawsuits over debt. The result of a successful bankruptcy is the discharge (cancellation) of debts that can legally be discharged. If your debt includes a home equity line of credit, and the court discharges that HELOC, you may still have to deal with the lender's claim on your home.

Bankruptcy Terms

In a chapter 7 bankruptcy, you petition for protection against creditors from a bankruptcy court, which at the end of the process will discharge your eligible debts. In return, you surrender any property that is nonexempt, which means property that the court trustee may sell in order to repay your creditors. Bankruptcy law allows some debts to survive, such as federal and state taxes, child support and federally guaranteed student loans. Loans secured by your property, such as a mortgage and a home equity line of credit, can be discharged. However, bankruptcy does not discharge the lender's lien on the house, which allows the lender to foreclose if the loan is not paid.

HELOC Terms

A home equity line of credit allows you to access your home's equity: the market value over and above the outstanding mortgage amount. If your home is worth $200,000, and your mortgage balance is $150,000, then you have $50,000 of equity, which a HELOC allows you to borrow in exchange for a "junior" lien on the house. The HELOC lender's claim is subordinate to that of the original mortgage lender, meaning the HELOC lender is second in line to collect any proceeds of a foreclosure. In addition, if your house is worth less than your first mortgage, you can petition a bankruptcy court to declare the HELOC loan as "unsecured," which would effectively cancel the loan as well as the lien.

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Discharge and Credit

If the HELOC survives the discharge of debts in bankruptcy, the lender still has the option to charge off the loan if you're unable to make payments after bankruptcy. Any charge-off of debt is reported to the credit bureaus, and will put a serious negative flag on your credit report; in addition, the bankruptcy flag remains there for 10 years, and will lower your credit score. The bankruptcy will make it difficult for you to secure new credit, for a home loan or any other loan. Even if 10 years pass and the flag disappears from your report, future mortgage lenders will ask about past bankruptcies. They can reserve the right to refuse you a loan if you've been through a bankruptcy, no matter when you filed for it.

HELOCs in Bankruptcy

If you reaffirm the HELOC debt, you agree to repay the loan after you emerge from bankruptcy. Reaffirming debt allows you to keep the property, as long as you keep up with the repayments you've agreed to. If you fail to repay the HELOC lender, or discharge the HELOC loan in bankruptcy, then the lender still has the right to foreclose on the house. This would result in seizure of your house and eviction. When the house is eventually sold, the HELOC lender must repay the principle mortgage lender first, and then may keep any remaining funds from the sale. If the proceeds are less than or equal to the principal mortgage amount, then the HELOC lender gets nothing. For that reason, a HELOC lender may be amenable to negotiating repayments, or refinancing the loan, even if you declare bankruptcy.

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What Happens if a Bank Discharges a Home Loan During a Bankruptcy?

References

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Can You Refuse to Reaffirm a Second Mortgage During Bankruptcy?

Although you've filed for bankruptcy, it is still possible to keep your home despite having a second mortgage on the property. You can enter into a reaffirmation agreement with the lender. By doing so, you agree to remain liable for debts secured by the property. However, you have to stay current and continue making payments. If you don't, you won't be able to discharge this obligation in the future, and the lender can come after you for the balance of the debt. If you have the chance to reaffirm a second mortgage and refuse, you may lose your home.

Can Creditors Attempt to Get Money After a Discharge?

When you file a petition for bankruptcy, you are asking a federal court for protection from creditors and time to work out your financial difficulties. In a Chapter 7 case, the court authorizes a trustee to seize your assets and sell them in order to repay creditors. In a Chapter 13, the trustee sets up a repayment plan, taking into consideration your assets as well as your income. Unless the case is dismissed, both kinds of bankruptcy conclude with a cancellation of debts you owe to some — but not all — of your creditors.

Chapter 7 Relief of Stay

In a Chapter 7 bankruptcy, a debtor petitions the court for protection from lawsuits and collection efforts. As soon as the petition is filed, the court grants an automatic stay. This is a legal restraining order that goes out to all creditors whom the debtor has listed on the petition. The stay has the effect of immediately suspending collection actions, and preventing any new actions while the bankruptcy is in progress. Creditors may request relief from the stay, which the court will grant if it has grounds to do so.

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