If you're one of the nearly 10 million Americans whose home lost so much value during the Great Recession it's still worth less than you owe, you may be considering one of several options to help you free yourself from this burden. You may not want the credit hit (and black mark against you as a future renter) that could come from a strategic default on your mortgage, and may not have the funds to buy your way back to zero equity in order to sell your home. While the bankruptcy process can provide some relief for struggling homeowners, recent court decisions may affect your ability to have certain mortgage-related debts discharged. Read on to learn more about how underwater mortgages are dealt with in Chapter 7 bankruptcy.
What mortgage debts can be discharged in a Chapter 7 bankruptcy?
Whether you file for Chapter 7 or Chapter 13 bankruptcy protection, your outstanding debt is placed into two categories -- secured and unsecured. In most cases, a Chapter 13 repayment plan will require you to turn over most of your monthly pay to the bankruptcy trustee, who will pay your debts in order of priority (with secured loans having priority over unsecured loans). A Chapter 7 bankruptcy, on the other hand, allows you to either reaffirm secured loans or relinquish your right to the collateral (like cars and homes) to help pay your debt. By reaffirming your mortgage, you'll be able to remain in your home and will continue to be responsible for this mortgage debt. If you wish to have this debt discharged, you'll need to give up your home and allow it to be sold at a bankruptcy sale in order to pay off the mortgage.
When you owe more on your mortgage than your home is worth, this process becomes a bit more complicated. On June 1, 2015, the U.S. Supreme Court handed down a decision that prevented homeowners from having second liens (like home equity loans and lines of credit) treated as unsecured loans in bankruptcy, and "stripped off" if the appraised price of the home is less than the amount of the first mortgage. Instead, these loans will be treated as secured loans, and if the value of your home is significantly lower than the total of all loans you have on your home, you may be required to give up other assets to help pay off this secured debt before your slate may be wiped clean. If you no longer want to live in your home, often it's easier to let your home go to foreclosure and then file bankruptcy to have any deficiency judgment levied against you by your lender discharged.
However, if you have no plans to leave your home, you'll be able to reaffirm your mortgage and continue making monthly payments until your mortgage matches your sale price and you're able to refinance to a lower rate or you have the freedom to relocate without having to bring money to the table.
Are there other options to help you reduce the debt you owe on your home?
One option you may wish to explore before filing for bankruptcy is a modification of your home mortgage through the Home Affordable Refinancing Program (HARP). This is a federal program designed to help homeowners struggling during the Great Recession and may allow you to refinance to reduce interest (and increase the amount you're paying toward principal), or even reduce the total amount of principal you owe. By taking advantage of this program, you can ensure that you're no longer throwing money at a depreciating asset and will be able to use the protections of bankruptcy to help eliminate your other debt.
Click to find out more about your bankruptcy options for getting out of debt.