By: Lance T. Denha, Esq.
As an attorney representing consumers facing outstanding debts and foreclosure, the primary reason that a consumer would file for bankruptcy is to protect against a deficiency judgment. Many homeowners may or may not have been informed, in discussing foreclosure, that losing their home is the end of the foreclosure road. However, this article is here to serve as confirmation that losing a home to foreclosure is not necessarily the final step, if a home is severely underwater.
In a typical foreclosure setting with homeowners, the proceeds from a foreclosure sale are supposed to satisfy the underlying mortgage debt. The bank will set a foreclosure sale date and sell the home to the highest bidder or may reacquire the home itself. Should the sale price at the foreclosure auction exceed what the bank is owed, then the homeowner will not be liable for anything further and the bank will not pursue the matter further. However, because real estate property suffering enormous losses leaves homes with essentially no equity, selling the home at a foreclosure doesn’t usually generate sufficient proceeds with which to satisfy the existing debt owed to the lender. If this is the case, a deficiency lawsuit is begun by a lender who will sue borrowers to hold them personally liable for their mortgage debts. As an aside, this same deficiency process plays a role in the short sale arena which is why it’s imperative for the homeowner and/or the agent representing the homeowner to review the loan agreement to ensure there is no outstanding deficiency balance that the seller could potentially be sued for down the road.
Handling deficiency liability after foreclosure could be in the form of two common methods; negotiating with the lender or filing a bankruptcy. Prior to considering bankruptcy consumers may want to negotiate with the lender to determine if they are able to pay a small portion owed to the lender in exchange for the lender no longer pursuing such deficiency at a later date. In considering the deal or lack thereof from the bank or collection agency handling the deficiency, if consumers are unable to work out a satisfactory deal with the lender, then the alternative typically results in pursuing the bankruptcy option. Filing for bankruptcy will either totally extinguish your liability or in the alternative reorganize your debt should you have additional collateral which may not be protected in a Chapter 7 Bankruptcy. Below is a summary of the two primary types of bankruptcies consumers utilize in an effort to get out of debt.
Although Chapter 7 is easier and does not require repayment, there are many good reasons why people who qualify for both types of bankruptcy choose Chapter 13 instead. Generally, Chapter 13 bankruptcy might make sense if debtors will have adequate, steady income to fund a plan for the appropriate period of time, and are in any of the following situations:
• Debtors are facing foreclosure on their home or their car is being repossessed. Using Chapter 13 bankruptcy protection permits debtors to make up the missed payments over time and reinstate the original agreement. Debtors generally cannot do this in a Chapter 7 bankruptcy. Instead they ultimately lose the property if they are behind on payments in a Chapter 7 bankruptcy.
• Debtors have more than one mortgage and are facing foreclosure because they cannot make all the payments. If debtor’s home value is less than or equal to what they owe on their first mortgage, debtors can use Chapter 13 to change the additional mortgages into unsecured debts, which do not have to be repaid in full, and lower the amount of their monthly payment.
Most people who have a choice traditionally have opted to file for Chapter 7 bankruptcy because it is relatively fast, effective, easy to file, and does not require payments over time. It also does not require you to be current in your income tax filings, unlike in a Chapter 13. In the typical situation, a case is opened and closed within three to four months, and the filer emerges debt free except for a mortgage, car payment, and certain types of debts that survive bankruptcy (such as student loans, recent taxes, and back child support).
If you have any secured debts, such as a mortgage or car note, Chapter 7 allows you to keep the collateral as long as you are current on your payments. However, if debtor’s equity in the collateral substantially exceeds the exemption available to you for that type of property, the trustee can sell, pay off the loan, pay debtors the exemption amount they are entitled under the bankruptcy laws, and pay the rest to their unsecured creditor. If debtors are behind on the payments, the creditor can come into the bankruptcy court and ask the judge for permission to repossess the car (or other personal property) or foreclose the debtor’s mortgage. As a general rule, however, most Chapter 7 filers are able to keep all their property because any equity they own is protected by an exemption.
Therefore, before debtors decide to file for bankruptcy, whether it is a Chapter 13 or Chapter 7 bankruptcy, debtors need to make certain bankruptcy is the right solution for their problem and then begin to assess which type of bankruptcy best fits their needs.