What Is Bankruptcy, How Does It Work, and How Can It Help Someone in Foreclosure?

Financial challenges can arise unexpectedly, and for people and homeowners who are overwhelmed by debt, bankruptcy may offer a path to regain control and find a fresh start. If you are facing foreclosure, filing for bankruptcy could be an option to explore, as it may offer relief and a chance to keep your home.

What Is Bankruptcy?

Bankruptcy is a legal proceeding in which a person or business that is unable to repay their debts seeks relief from some or all of their financial obligations. It provides a structured process for dealing with debts under the supervision of the court, allowing the individual or business to either wipe out (discharge) certain debts or create a repayment plan.

When a person files for bankruptcy, the court imposes an automatic stay, which temporarily halts most creditors from pursuing collections efforts, including foreclosure. This pause can offer much-needed time to explore other solutions or reorganize finances.

Types of Bankruptcy: Chapter 7 vs. Chapter 13

There are several different types of bankruptcy filings, but the two most common for individuals are Chapter 7 and Chapter 13. Let’s take a closer look at each:

Chapter 7 Bankruptcy: Liquidation Bankruptcy

Chapter 7 is often referred to as “liquidation bankruptcy” because it involves the sale of certain assets to repay creditors. This type of bankruptcy is designed for individuals who have a lot of unsecured debt (such as credit card debt or medical bills) and little or no income or assets to repay it.

When someone files for Chapter 7, a bankruptcy trustee is appointed to sell off non-exempt assets to pay off creditors. The goal is to discharge (eliminate) most unsecured debts, leaving the filer with a fresh financial start. A Chapter 7 bankruptcy typically takes about 4 to 6 months to complete from the filing date.

How It Helps in Foreclosure:

- Automatic Stay: As soon as Chapter 7 is filed, an automatic stay goes into effect, halting the foreclosure process temporarily. This gives the homeowner time to decide how to move forward—whether that means surrendering the property, negotiating with the lender, or pursuing another solution.

- Discharge of Debt: If the homeowner’s mortgage payments are behind due to financial struggles, Chapter 7 may help eliminate other debts, freeing up funds to catch up on their mortgage and avoid foreclosure.

However, it’s important to note that Chapter 7 may not help save a home if the homeowner is behind on mortgage payments and the property is underwater (i.e., the mortgage exceeds the property’s value). Chapter 7 doesn’t provide a repayment plan for delinquent mortgages, so the lender may still proceed with foreclosure if no other solution is found.

Chapter 13 Bankruptcy: Reorganization Bankruptcy

Chapter 13 is often called “reorganization bankruptcy” because it allows individuals with regular income to create a repayment plan to pay back all or part of their debts over a period of three to five years. This type of bankruptcy is designed for people who have more income and want to keep their assets, including their home. A Chapter 13 bankruptcy usually takes 3 to 5 years to complete, depending on the repayment plan approved by the court.

How It Works:

- The filer proposes a repayment plan that outlines how they will pay off their debts over time. The plan is submitted to the bankruptcy court for approval, and once it is approved, they make monthly payments to a trustee who distributes the funds to creditors.

- Debt Restructuring: Debts are often restructured, and the homeowner may get lower payments, reduced interest rates, or even debt forgiveness in some cases.

How It Helps in Foreclosure:

- Stop Foreclosure: One of the primary benefits of Chapter 13 for homeowners facing foreclosure is the ability to stop the process entirely. The automatic stay that goes into effect when filing Chapter 13 prevents the lender from foreclosing on the home.

- Catch Up on Mortgage Payments: Chapter 13 allows the homeowner to incorporate their past-due mortgage payments into the repayment plan, meaning they have the opportunity to catch up on missed payments over several years.

This can help prevent the loss of the home through foreclosure while reorganizing other debts at the same time.

- Possibility to Keep the Home: If the individual is able to meet the payment plan requirements and stay current with their mortgage payments, they can avoid foreclosure and keep their home.

How to File for Bankruptcy

Filing for bankruptcy involves several steps. Here’s an overview of the process:

1. Evaluate Your Financial Situation: The first step is to assess your debts, income, and assets to determine whether bankruptcy is the right option. Consulting with a bankruptcy attorney is recommended, as they can help explain your options and guide you through the process.

2. Pre-Filing Credit Counseling: Before filing, you must complete a credit counseling course from an approved agency. This is required by law and must be done within 180 days before filing.

3. File a Petition: Once you have completed the necessary counseling, you’ll file a bankruptcy petition with the court. This includes submitting detailed financial documents, including income, expenses, assets, and debts.

4. Attend the Meeting of Creditors: After filing, a meeting of creditors will be scheduled, where you’ll meet with the bankruptcy trustee and any creditors who choose to attend. You’ll be asked questions under oath about your financial situation.

The trustee is also compensated through a percentage of the payments made by the debtor, so part of their role is to ensure the repayment plan is practical and likely to succeed, benefiting both the filer and the creditors.

5. Repayment Plan or Liquidation: Depending on whether you’re filing Chapter 7 or Chapter 13, you’ll either work with the court to create a repayment plan (Chapter 13) or liquidate assets (Chapter 7).

6. Discharge of Debts: If the court approves your bankruptcy petition, most of your unsecured debts will be discharged, and you’ll receive a fresh financial start.

With both Chapter 7 and Chapter 13 certain debts are exempt from discharge. These typically include obligations like child support, alimony, most student loans, certain tax debts, and debts arising from fraud or criminal acts.

While Chapter 13 allows for a structured repayment of these non-dischargeable debts, they generally cannot be eliminated entirely through the bankruptcy process.

Final Thoughts

Bankruptcy can be a lifeline for homeowners in foreclosure, offering them time to reorganize their debts and potentially save their homes. While Chapter 7 may provide relief by wiping out unsecured debts, Chapter 13 offers a more comprehensive solution by restructuring debts and allowing homeowners to catch up on missed mortgage payments.

If you’re facing foreclosure, speaking with a bankruptcy attorney can help determine whether bankruptcy is the best option for you. It's important to weigh all possible solutions, including bankruptcy, before making a decision, as there may be other ways to keep your home or eliminate unnecessary debt.

At Just Jolly Investments, we understand the complexities of foreclosure and financial hardship, and we’re here to provide a no-obligation offer or help connect you with professionals like realtors or bankruptcy attorneys who can help guide you through the process.

Source: Attourney Cara Oneil Chapter 13 Bankruptsy Keep Your Property & Repay Debts Over Time 2022

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