Bankruptcy’s Role in the Foreclosure Process

The United States Bankruptcy Code provides protection to individuals and families from creditors efforts to collect their debts. Bankruptcy is intended to provide an orderly process for the resolution of debts and in some cases an opportunity to reorganize a debtors’ financial affairs.

There are three primary tools at work in the Bankruptcy Code for those facing foreclosure and for debtors generally. They are:

1) The Automatic Stay
2) Lien Stripping
3) Discharge

The Automatic Stay provision of the Bankruptcy Code requires that creditors cease all collection actions upon the debtor’s filing of a bankruptcy petition. Bankruptcy petitions filed prior to the completion of the foreclosure process will halt (Astay@) the continuation and completion of the foreclosure. A mortgage company notified of the commencement of a bankruptcy petition by a debtor is required to cease further efforts to foreclose or collect the mortgage debt pending a bankruptcy court order authorizing them to proceed. The filing of a bankruptcy petition by a debtor thereby allows additional time to the debtors to remain in their home, possibly negotiate a resolution with the mortgage company, or to propose a plan under Chapter 13 of the Bankruptcy Code to repay their past due mortgage debt (mortgage arrears) over a period of three to five years.

Lien Stripping allows a debtor to request the bankruptcy court issue an order voiding attachments, judicial liens and, in limited circumstances, second and third mortgages can be removed and voided by a bankruptcy court. A second or third mortgage can be voided by bankruptcy court order under circumstances where a debtor files a chapter 13 reorganization case and can show the bankruptcy court that the principal balance of their primary mortgage (first mortgage) exceeds the current fair market value of their home. This analysis results in a finding that a second or third mortgage against the residence is Awholly unsecured.@ Under these circumstances the court can issue an order voiding a second or third mortgage.

At the conclusion of the bankruptcy process the bankruptcy court issues an order discharging a debtor’s obligation to pay debts. The Discharge Order removes a debtor’s obligation to pay the vast majority of consumer debts including credit card bills, personal loans and secured debts including car loans, mortgage home loans, etc.

A word about secured loan treatment and bankruptcy. A debtor’s obligation to pay a secured loan is discharged at the conclusion of a bankruptcy case; however, the nature of a secured loan means that the debtor has pledged collateral (a home for a mortgage, title to the car for a car loan, etc.) as security for the repayment of the loan. While a discharge order absolves the debtor from repaying the bank loan, the bank or mortgage company still has rights to repossess or foreclose on the collateral absent a court order voiding the mortgage company’s security interest.

For more information on your bankruptcy options, please visit our Chapter 7 vs. Chapter 13 Bankruptcy page.