Can I Save My House in a Chapter 7?

Chapter 7 is usually not the best type of bankruptcy to save your house if you are behind in your monthly mortgage payments. Filing Chapter 7 might delay foreclosure, but the lender has the option of seek judicial approval to foreclose even during your bankruptcy.

If you have non-exempt equity in your house and you are far behind in your payments, there is a substantial risk that you will lose your home in Chapter 7. A Chapter 13, a wage earner plan, is usually the better option.  We have a separate pull-down set of menus in this website about Chapter 13 and how to save your house.

The starting premise is this: You are obligated to make your mortgage payments even if you file bankruptcy.

To put a fine point on it, even if you are current in you payments, just filing bankruptcy is a violation of your mortgage terms, and gives your lender the option of foreclosing. Most lenders, however, are not that eager to foreclose to get the property back if the payments are current. Usually the fact that you filed bankruptcy is not enough to trigger a foreclosure. But if you are behind in payments, then filing a Chapter 7 bankruptcy may well trigger a lender’s motion for leave of court (court’s permission) to start the foreclosure process.

If the homestead exemption covers your equity (the difference between fair market value and loans against your house, and minus selling costs), the bankruptcy trustee will not be very interested in selling your house because there will be nothing left over to pay to unsecured creditors. Your home lenders would get paid their loan amounts, and the exemptions would ensure that you get what is left over. So, if you are current on your payments, you and the lenders can work out reaffirmation agreements.

One way in which Chapter 7 may help you avoid losing your house is by reducing your debt load. If much of your other debt is discharged, you suddenly may have enough cash flow to stay current on your mortgage payments or even catch up with missed payments. In this situation, a Chapter 7 might be a better fit than a Chapter 13.

These methods are sometimes best employed before you file Chapter 7. These require a cooperative lender. As noted above, some of them might become viable after other debt is discharge and your cash flow situation improves.

Examples include the following:

  • Increase monthly payments to pay back missed monthly payments.
  • Reduce monthly payments for a specified time, adding the unpaid portion to the total loan amount.
  • Extend the loan payback period and add the missed payments to the loan amount.
  • Refinance your loan to reduce future monthly payments.
  • Let you sell the property for less than the loan balance and wave the balance of the loan owed (a “short sale”).

Be realistic. If you don’t really have the means of paying the mortgage, even after a workout or modification, you are probably not going to be able to keep your house.

Even if foreclosure on your house is a foregone conclusion, there are still advantages to filing a Chapter 7.

First, the foreclosure may be supervised by the bankruptcy trustee who will have an interest in seeing that the sale price is as high as feasible. If you have equity in the house protected by the homestead exemption, the trustee will help maximize this amount.

Second, if the house is sold at foreclosure for less than the debt amount, the difference is treated as income by the IRS if the lender does not seek payment of the deficiency amount. However, that IRS income treatment is avoided if you were insolvent at the time of the debt waiver or the waiver occurred in a bankruptcy. It is much easier to convince the IRS of the fact of a bankruptcy than the status of insolvency. This whole issue of IRS tax treatment of debt forgiveness is very complex and unfortunately doesn’t surface until long after the foreclosure. Many foreclosed home owners are blindsided by it, sometimes years after the foreclosure when proof of insolvency may be impossible to assemble. Proof of filing bankruptcy is much easier to provide.