When Does Bankruptcy Beat Foreclosure?

Facing foreclosure can be scary. You’ve probably been struggling to make your mortgage payments for awhile now. Maybe you lost your job or your hours got cut back. Or maybe you or a family member got sick and had huge medical bills. Whatever happened, you got behind on your mortgage and now the bank is threatening to take your house.

You’re not alone – millions of Americans are in the same boat. And many are turning to bankruptcy as a way to stop the foreclosure and save their homes. But does bankruptcy really beat foreclosure? And if so, when is it the best option?

How Bankruptcy Can Stop Foreclosure

Filing for bankruptcy triggers something called an “automatic stay.” This is a court order that requires all creditors, including your mortgage lender, to immediately stop any collection actions against you. That includes foreclosure proceedings.

So if your house is scheduled for a foreclosure sale, filing for bankruptcy will halt the sale – at least temporarily. This automatic stay is one of the biggest benefits of filing for bankruptcy. It gives you immediate protection and breathing room.

Chapter 7 Bankruptcy

Chapter 7 bankruptcy is what’s known as a “liquidation” bankruptcy. It discharges (erases) most of your unsecured debt like credit cards, medical bills, personal loans etc. But it doesn’t erase your mortgage.

Chapter 7 will stop the foreclosure while your bankruptcy is pending – usually about 3-4 months. This can buy you some time to move out. But once your bankruptcy is complete, the lender can just restart foreclosure proceedings.

So Chapter 7 provides only temporary relief. It stops the foreclosure but doesn’t address the underlying problem – your inability to pay the mortgage. For that reason, Chapter 7 usually just delays foreclosure rather than preventing it altogether.

Chapter 13 Bankruptcy

Chapter 13 bankruptcy is very different. It’s known as a “reorganization” bankruptcy because it gives you 3-5 years to catch up on late payments through a court-approved repayment plan.

Your repayment plan will include both your regular monthly mortgage payment plus some extra each month to chip away at the past due amount. This allows you to reinstate the mortgage and avoid foreclosure altogether.

Chapter 13 is the better option if you want to save your home. The automatic stay stops the foreclosure just like Chapter 7. But then your repayment plan cures the default over time. So Chapter 13 provides a long-term solution.

When Does Bankruptcy Beat Foreclosure?

Now that you understand the basics of how bankruptcy interacts with foreclosure, let’s look at some scenarios where filing bankruptcy may be your best move:

1. You Need Time to Move

Maybe you’ve realized there’s just no way you can catch up on the mortgage. You’re facing imminent foreclosure and need time to find a new place to live.

Filing a Chapter 7 bankruptcy would stop the foreclosure for a few months, giving you time to move out. The lender can eventually resume foreclosure. But at least you won’t get kicked out on the street.

2. You Can Catch Up With 3-5 Years

If you only need some breathing room to get back on your feet financially, Chapter 13 may save your home. Your repayment plan will be based on what you can afford. So even if you can only pay a little extra each month, it may be enough over 3-5 years.

3. Your Lender Won’t Negotiate

Lenders are often willing to modify loans for borrowers in default. But sometimes they simply refuse to negotiate in good faith. Bankruptcy may be your only leverage.

The threat of bankruptcy can bring lenders to the table. If that doesn’t work, filing Chapter 13 stops foreclosure and forces the lender to accept a court-ordered repayment plan.

4. You Have a Lot of Other Debt

Maybe you have so much credit card, medical or other debt that you can’t afford your mortgage plus those payments. Bankruptcy eliminates most other debts, leaving more room in your budget for the mortgage.

5. You Have No Other Options

If you’ve tried everything else – loan modifications, short sales, deeds in lieu of foreclosure – with no success, bankruptcy may be your last resort. It’s certainly better than letting the home go into foreclosure.

Downsides of Bankruptcy

Bankruptcy can be an effective tool against foreclosure. But it also has some significant downsides, including:

• Your credit score will drop drastically and stay low for years.
• Future borrowing will be very difficult or expensive.
• Bankruptcy stays on your credit report for 7-10 years.
• You may have to give up valuable assets to repay debts in Chapter 7.
• The court controls your finances in Chapter 13.

Bankruptcy should never be your first option when facing foreclosure. Explore all alternatives, like loan modifications, first. But if you’ve run out of options, bankruptcy may be better than losing your home.

Strategic Timing of Bankruptcy

Timing is everything if you want to stop foreclosure with bankruptcy. The most important thing is filing before the foreclosure sale. Once the sale happens, it’s generally too late for bankruptcy to undo it.

Ideally you want to file bankruptcy with enough time for the automatic stay to kick in before the sale. This varies by state, but aim for at least a few weeks’ buffer.

It’s also usually better to file sooner rather than later. The stay only lasts so long and lenders can ask to lift it. So file as soon as you decide bankruptcy is your best course.

The Bottom Line

Bankruptcy can be an effective last resort against foreclosure. The automatic stay stops the foreclosure in its tracks, buying you time. In some cases, Chapter 13 bankruptcy can cure the default and prevent foreclosure altogether.

Bankruptcy has downsides and should not be your first choice. But in many situations, it beats foreclosure and saves your home. Talk to a bankruptcy lawyer to explore whether it’s the right option for your situation.

With the right legal strategy, you may be able to stop the foreclosure and keep your house.