How does bankruptcy work with a foreclosure?


Foreclosure is a legal procedure by which a mortgage lender can take possession of a house when the borrower does not make the monthly payments. Foreclosure is different in every state, and in Minnesota it is a complicated process which cannot be fully explained in one paragraph. The following explanation is only a short description of the stages and timing of foreclosure, and how bankruptcy can play into it.


After you miss one or two monthly payments on the mortgage, banks will usually send a letter saying you are in default. This letter will usually urge the borrower to make payments to catch up or make some sort of arrangement with the bank. If the default is not fixed after another month or two, the bank will start the foreclosure process by sending a letter called a Sheriff's Sale Notice. Usually a sheriff's sale will be scheduled for 4 weeks after this date. The sheriff's sale is an auction where people can bid on the house. The lender, however, almost always wins the auction and takes the house. In certain circumstances, especially where there is a second mortgage, the lender can try to collect any balance of the loan above the price paid at the sheriff''s sale. This debt, called a deficiency continues after the sheriff's sale. It is usually dischargeable in bankruptcy.

On the day of the sheriff's sale, the bank takes title to the house and the redemption period begins. The redemption period is made to protect borrowers from abuses by lenders and usually lasts for 6 months. During the redemption period the borrower can live in and occupy the property, but doesn't have to pay the mortgage or property taxes. During this period the borrower may also buy back the house for the price paid at auction, but this is difficult because lenders won't lend to people right after a foreclosure. After the redemption period has ended, the borrower can be evicted, and must find somewhere else to live.


Filing for bankruptcy can help someone with a foreclosure in one of two ways, but it must be filed before the sheriff's sale. First, a Chapter 13 Bankruptcy can help you catch up on your payments if you fell behind on your mortgage. Second, a Chapter 7 can allow you to stay in the house longer and stop the lender from trying to collect a deficiency from you after taking the house. These options are explained in more detail below.


If you have fallen behind on your house payments, but still have an income large enough to pay for the mortgage, you are a good candidate for a Chapter 13. This is especially true if you have some equity in your home, and want to keep it. A Chapter 13 allows you to pay the arrears (the amount you are behind) over a period of 3-5 years while you make the regular mortgage payments. After the arrears are paid off, the mortgage will no longer be in default, and you can continue to live there and make the normal monthly payments.


If your house is underwater because the balance of your mortgage is higher than the value of your house, or you can't afford the monthly payments, then a Chapter 7 can help you. When you file a Chapter 7 you are legally protected from actions to collect a debt, including holding a sheriff's sale on a foreclosed house. This protection lasts for up to three months, although a lender can still ask the court for special permission to hold a sheriff's sale. After filing the case, the lender must ask the court for permission to foreclose, and schedule another sheriff's sale, usually 4 weeks in the future. So filing bankruptcy can give you an additional 1 to 3 months in the house without paying the mortgage.

More importantly, the Chapter 7 discharges any deficiency debt in case the house sells at auction for less than the mortgage, which is very common. So long as you don't sign a reaffirmation agreement, the Chapter 7 protects you against the deficiency even if you file for bankruptcy before the foreclosure. Deficiency judgments can be quite large, sometimes over $50,000 when the house is underwater and there is a second mortgage, so a Chapter 7 can be very powerful.

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