How Does Bankruptcy Affect A Mortgage? Bankruptcy Options and How They Affect Your Mortgage
Kevin Graham13-minute read
October 30, 2020
Bankruptcy is a bummer. No one has ever said “OH MAN! I’m so excited to file bankruptcy! It’s going to make everything so awesome!” That being said, sometimes it needs to be done.
If you’ve explored all of the alternatives and have decided to file bankruptcy, it’s important that you know what your options are and how they will impact your existing mortgage, or your future ability to obtain home loan financing.
One quick note before we move forward: This resource is going to cover Chapters 7 and 13 bankruptcy filings because these are the ones most commonly utilized by bankruptcy filers, but self-employed people may be able to file Chapter 11 bankruptcy. Chapter 12 bankruptcy is available to fishermen and farmers. If you qualify for one of these, you may have different options.
While this is intended to serve as a resource, it’s in no way meant to serve as a legal advice. Be sure to consult with a law firm with bankruptcy attorneys who can discuss options and procedures in your jurisdiction.
What’s The Difference Between Chapter 7 And Chapter 13?
If you’re considering filing bankruptcy, you should understand the options that are out there. Chapters 7 and 13 bankruptcies are the most used alternatives for individuals.
Chapter 7 bankruptcy is also known as total bankruptcy. It’s a wipeout of much (or all) of your outstanding debt. Also, it might force you to sell, or liquidate, some of your property in order to pay back some of the debt. Chapter 7 is also called “straight” or “liquidation” bankruptcy. Basically, this is the one that straight-up forgives your debts (with some exceptions, of course).
Chapter 13 bankruptcy is more like a repayment plan and less like a total wipeout. With Chapter 13, you file a plan with the bankruptcy court detailing how you will repay your creditors. Some debts will be paid in full, while others will be paid partially or not at all, depending on what you can afford. Chapter 7 = wipeout. Chapter 13 = plan.
The Effects Of Bankruptcy On An Existing Mortgage
If you declare bankruptcy, there are established procedures of due process. You don’t automatically lose your house. Nor is your loan accelerated to automatically become due if you’ve been current up to this point on your payments.
The following sections will go over how bankruptcy affects your current mortgage.
How Does Chapter 7 Bankruptcy Affect My Existing Mortgage?
When you file Chapter 7, your existing property will be deemed either exempt or nonexempt. Exempt means you’ll be able to keep the property throughout the bankruptcy process, as long as you can catch up and stay current on your payments.
Nonexempt means you will either be required to surrender the property or pay its value in cash as a part of the bankruptcy. In some cases, people are allowed to keep nonexempt properties. It all depends on the bankruptcy trustee and how they choose to handle the property.
To understand how Chapter 7 impacts your existing home mortgage, you must first understand the difference between a loan and a lien.
When you get a mortgage, your mortgage company gives you a loan. They let you borrow money in order to buy a property. When they do that, they place a lien on the property. A lien is a right or interest in the property that the mortgage company has until the debt (or loan) is paid in full.
When you file Chapter 7, you are no longer legally obligated to repay the loan. “Legally obligated” is the key phrase here because Chapter 7 does not get rid of the lien on the property. Your lender still has a right to the property if the debt is not paid.
So basically, you don’t have to pay your mortgage. But if you don’t you will lose your property because your lender will likely enforce the lien they have. If you are able to keep your home as part of Chapter 7, it’s probably a good idea to do everything in your power to keep paying your mortgage loan.
How Are Exemptions Determined In A Chapter 7 Bankruptcy?
Since your house has to be considered exempt from the bankruptcy in order to have the most favorable scenario for keeping your house, it’s important to know how exemptions are determined. How your home is handled in a bankruptcy is determined by state or federal homestead exemptions. While specifics will vary by state, here’s how the exemption works.
There’s usually a certain period you must have lived in the house before it can be considered for an exemption. For example, if you file under the federal statute, you must have owned the home for 40 months.
The second key determinant for an exemption is the amount of equity you have in the home, which requires knowing your home value. State and federal statutes let you exempt a certain amount of equity from being used by a trustee to pay off creditors and lenders. The exact amount that you can protect will vary from state to state.
Be sure to check the law in your state. Certain states allow you to double the amount of equity exempted if you file for bankruptcy jointly as a married couple.
The important thing to remember is that if you have enough equity that you fall above the exemption amount, your bankruptcy trustee may choose to sell your home to pay back creditors. They’ll pay you back for any exempted equity following the sale, but you’ll have to find a new home.
In certain situations, you may have the option of reaffirming the debt to avoid losing the house if you continue making your payments. However, speak to your bankruptcy attorney and mortgage servicer about how to handle the process and what your options are.
There are instances in which you may have options in deciding which exemption rules apply, so speak with your bankruptcy attorney.
What About Chapter 13? What Happens With My Existing Mortgage?
With a chapter 13 bankruptcy, borrowers will not lose their property. You will include details on how you plan on paying your mortgage in your repayment plan. In most cases, an automatic stay is issued once Chapter 13 is filed. An automatic stay means that creditors must stop collection efforts.
It was designed to temporarily halt foreclosure and stop repossession of homes regardless of the stage of the foreclosure proceedings. For homeowners with too much equity to qualify for a homestead exemption in their jurisdiction, this is an advantage of a Chapter 13 filing.
There are a couple of important caveats here: First, you have to stay current on any mortgage payments that are due after the filing. If you’re behind on your payments, missed payments can be included in your reorganization plan, but you have to make sure all these debts are paid back by the end of your plan timeline.
Can You Get A Mortgage While In Bankruptcy?
The short answer to this question is no. All major lenders and mortgage investors require that the bankruptcy be either discharged or dismissed before application. Moreover, many loan types require a waiting period before you can even apply.
Getting A Mortgage After Bankruptcy
You may not be able to get a mortgage during bankruptcy, but you can get one after bankruptcy if you otherwise qualify. Nonconforming loans like those from government agencies may not even have a waiting period.
Before we get into specifics around guidelines, it’s also worth noting in general that a bankruptcy of any kind has a major negative impact on your credit. It’s not impossible to move forward and get a mortgage down the line, but you may have some recovery to do. A secured credit card or credit builder loan can help. Check out this post on buying a house with bad credit.
How Long Do I Have To Wait After Chapter 7 To Get A New Mortgage?
Most reputable lenders, including Quicken Loans®, will not consider you for financing until 2 years after the Chapter 7 bankruptcy has been discharged. If you find a lender who will consider you prior to 2 years, make sure you are fully aware of all the terms and conditions included in your mortgage. Scrutinize the details and look at all the costs to ensure you’re not being scammed.
It’s important to note that your options for a mortgage will be limited after a Chapter 7 bankruptcy. FHA and VA loans require a 2-year waiting period prior to application after the bankruptcy has been discharged or dismissed. If you’re getting conventional or jumbo loan, you have to wait 7 years after discharge or dismissal before applying.
How Long Do I Have To Wait After Chapter 13 To Get A New Mortgage?
Quicken Loans and other lenders may give you the option of getting an FHA or VA loan as long as the Chapter 13 bankruptcy is discharged or dismissed before you apply.
If you're looking to apply for a conventional loan, it matters whether your bankruptcy was discharged or dismissed. In the event of a Chapter 13 discharge, the discharge date has to be more than 2 years prior to the date credit is pulled and more than 4 years since the filing.
If the bankruptcy was dismissed, there’s a 4-year waiting period until credit can be pulled for a new conventional mortgage.
Finally, jumbo loans still have a 7-year waiting period before you can apply.
Waiting Periods For Other Bankruptcies
While the legal implications behind debt discharge or dismissal outside of Chapters 7 and 13 bankruptcies are beyond the scope of this article, we can share the waiting periods for getting a new mortgage if you’ve filed Chapter 11 or 12 bankruptcies in the past.
For Chapter 11 bankruptcies, you can get a mortgage through the FHA or VA as long as you otherwise qualify and the bankruptcy was discharged or dismissed 2 years prior to application. The waiting period for conventional loans is 4 years and 7 years for jumbo loans.
For a Chapter 12 bankruptcy, conventional loan policy again differentiates between discharge and dismissal. If the bankruptcy is discharged, that has to have happened more than 2 years prior to application and it has to be filed more than 4 years ago. When the bankruptcy is dismissed, the waiting period is 4 years.
With an FHA loan, the bankruptcy only needs to be discharged or dismissed before you apply. Meanwhile, the VA has a 3-year waiting period prior to application.
Filing for bankruptcy is a big decision that has a lot of implications for your current and future financing. Make sure you discuss your options with a lawyer or your financial advisor before you stop making payments or file for bankruptcy.
Frequently Asked Questions Around Mortgages And Bankruptcy
We’ve gone over the biggest pieces of the puzzle, but there are other considerations around bankruptcy when it comes to your mortgage. Let’s take a quick look at a few of them.
Does Bankruptcy Discharge Mortgage Debt?
The answer to this question really depends heavily on the type of bankruptcy being filed. We’ll go over the scenarios for Chapters 7 and 13 bankruptcies because these are the most common, but if you have any questions, please consult your bankruptcy attorney.
We referred to Chapter 7 above as the “wipeout” bankruptcy because you’re relieved of your responsibility for the debt. However, if you want to keep your home and car, you’ll need to keep your mortgage and car loans. If you don’t stay current on your payments, your mortgage lender can foreclose, and the car can be repossessed.
Chapter 13 bankruptcies are about reorganization, so you can use this type of bankruptcy to pay back debts according to the timeline in your plan while staying current on any mortgage payments after the bankruptcy is filed. Unlike Chapter 7, under Chapter 13 bankruptcy, you’re still responsible for the debt.
How Do Bankruptcies Affect A Joint Mortgage?
If one person files for bankruptcy, that can have an impact if you both are on the mortgage. There are instances where one person’s bankruptcy can cause issues with keeping the home, even if more than one of you is on the mortgage. In order to be fully apprised of what can happen, talk to your attorney.
Do Bankruptcies Affect Second Mortgages?
Second mortgages and home equity lines of credit (HELOCs) are also impacted by bankruptcies. If you have a second mortgage or HELOC, you’re not responsible for it under a Chapter 7 bankruptcy, but you’re required to keep paying on it if you want to keep the house without a problem.
Things become a little more complex with a Chapter 13 bankruptcy. If you can prove that your existing equity isn’t enough to cover what you owe on a second mortgage or HELOC, you can present that evidence in bankruptcy court. If a judge agrees, the junior lien taken out after your first mortgage may be stripped off.
One thing to note is that a lender may fight this, so to give yourself the best chance of success, you may want to have an appraisal done before you file for bankruptcy.
Before going through a bankruptcy, consider whether that’s what you actually need. Because the credit history consequences can be enormous, including a nearly 250-point decrease for someone with a 780 FICO® Score. Because it stays on your credit report and is reported by each credit bureau for between 7 and 10 years, it should really be the option of last resort.
The credit score drop also means that when you do requalify for a mortgage, you may have a hard time getting competitive mortgage rates when compared to others with a similar down payment or equity amount, but no bankruptcy. Let’s look at the alternatives.
If You’re Having Trouble With Your Mortgage Payment
It’s probably best to start by talking about what to do if you’re having trouble with your mortgage. It’s our expertise, but also for many people, it’s their single biggest monthly expense. If you find yourself struggling, you have a few options for mortgage help.
The most preferable option for most people might be to look at a modification. A mortgage modification involves temporarily or permanently lowering your interest rate and/or extending your term so that you can more easily afford your monthly payment.
If you’ve been over things with your servicer and can afford to make a payment at all, one option might be a short sale. In this scenario, you might know you can’t sell your home for what you owe on your mortgage. However, if you can prove hardship, your lender might be willing to let you do a short sale where they work with you to sell the property for less than what you are.
Depending on state law, a lender may be able to go to court and get a judgement against you for the difference between what the property sells for and what you actually owe, so that’s something to be aware of.
Finally, your lender could approve a deed in lieu of foreclosure. Under this arrangement, you sign the property over to your lender and they then sell the home. In exchange for keeping the home in good shape, your lender may forgive some or all of the difference between what you actually owe and what the property can be sold for.
The benefit to all of these options is that while they still have a negative impact on your credit score and you could lose your home, the credit affect is not as drastic as it would be with a foreclosure or bankruptcy.
The drawback of these options is that your lender doesn’t have to approve anything. They could insist on foreclosing on your home. However, if you have a legitimate hardship and want to work with your lender, they may entertain working with you because the cost of foreclosure is expensive from a legal fee and maintenance perspective.
Lenders will want to see evidence of hardship. Be prepared to give a full accounting of your financial situation. To that end, you’ll want to be able to show the cause (e.g. permanent or temporary loss of income or high medical bills). Your lender will also ask for bank and credit card statements to make sure you’ve really tried to cut unnecessary items from your budget.
If you’re a Quicken Loans client having trouble making your mortgage payment, you can apply for assistance online with our Application for Success. You can also feel free to speak with our Servicing Team at (800) 508-0944.
Negotiating With Other Creditors
While your mortgage is significant, it’s obviously not your only bill. Other lenders and creditors may work to negotiate with you if you can go through the process of proving hardship. If you can come to an agreement, you may be able to settle your debt, even if it’s less than what you owe.
It can be tempting to let unsecured debt default, but doing this will really hurt your credit score. Instead, we suggest working something out. Paying something may make a creditor more receptive to giving you some debt relief.
There’s still a credit ding that comes along with having an account that’s paid as agreed rather than being paid in full, but it’s better than having an account that goes to collections or charge-offs. Some money is better than no money, and it does help lessen the effect on your credit score.
Bankruptcy isn’t good for your mortgage or any other aspect of your finances. Still, it doesn’t have to be a monetary death sentence. A Chapter 7 bankruptcy wipes out your financial debt including your mortgage, but you could lose your house. A Chapter 13 bankruptcy is more of a real organization and you can even catch up on payments as long as these are included in your plan.
Keeping your home in a Chapter 7 bankruptcy will largely depend on whether your home is exempt or nonexempt. Chapter 13 bankruptcy lets you keep your home as long as you make payments in accordance with your plan. If you do get to keep your home, make sure your payments stay current.
It’s possible to get a mortgage after bankruptcy is dismissed or discharged. Some loan types require a waiting period after the bankruptcy is over, while others don’t. It’s important to be able to rebuild your credit in any case before applying again. Bankruptcy has a long-term effect on your credit report and score.
Finally, because bankruptcy involves a major credit hit, you should consider all possible alternatives including negotiations with creditors. If you’re having trouble making your mortgage payment, you might consider applying for a modification, short sale or deed in lieu of foreclosure.
If you’ve gone through a bankruptcy and feel like you have your credit in good shape to buy or refinance again, check out our mortgage calculator to see what you can afford. You can apply online with Rocket Mortgage®