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How does a bankruptcy filing affect the mortgage for my home? This is a common question, and there are several ways in which bankruptcy can impact your home mortgage.
First, it is important to understand that a mortgage, as it is commonly called, consists of two separate legal documents. The first is the mortgage note. The individual signing the note has a personal obligation to repay the loan. This means that if the loan goes into default, the individual can be sued for the money that is owed. In New York, this rarely happens with first mortgages, but is common with second mortgages or home equity loans.
The second document is the mortgage itself. A mortgage is a lien on the real property that is being purchased or refinanced. The person signing the mortgage, known as the “mortgagor”, is agreeing that in the event of a default, the lender, known as the “mortgagee”, can foreclose on the property. This means that the lender can bring a court proceeding to sell the property to satisfy the amount due under the mortgage note.
Everyone whose name is on the deed to the property must sign the mortgage. This is because the mortgage is giving the lender a lien on the property, and, therefore, all of the property owners must sign the mortgage. However, only individuals who sign the note are personally liable for the loan. For example it is common for only one spouse to sign the mortgage note, because his or her credit is better, while both spouses must sign the mortgage, if the property is jointly owned. Consequently, not all persons on the mortgage are necessarily personally liable to pay the mortgage loan.
In New York, foreclosure can only be done through a judicial procedure. Most foreclosure sales result in a “deficiency”, meaning the proceeds of the sale are insufficient to repay the mortgage loan in full. In that case, the lender can ask the court for a money judgment against the borrower for the amount of the deficiency. Keep in mind that only individuals who signed the mortgage note can be held personally liable for a deficiency. While lenders usually do not pursue deficiency judgments in New York, borrowers that are in foreclosure must be aware of this possibility, especially if they have other assets or income from which a deficiency judgment could be satisfied.
In a Chapter 7 bankruptcy, the debtor’s personal obligation to repay the mortgage note is discharged. This is because, in Chapter 7, all pre-petition debts (i.e. debts that arose before the bankruptcy filing) are discharged, unless one of the exceptions to discharge applies. Keep in mind that it is the personal obligation that is discharged, not the mortgage lien.
What is the effect of the discharge of a mortgage in Chapter 7, in practical terms? If the debtor stays current with the mortgage, the Chapter 7 bankruptcy will have no practical effect on the mortgage. That is, the debtor will continue to pay the mortgage until it is paid in full (or refinanced or the property sold).
If the debtor defaults, however, the lender can proceed with foreclosure. While the Chapter 7 discharge protects the debtor from a personal deficiency judgment, the discharge does not protect the property from being foreclosed on.
Second mortgage holders will rarely file foreclosure actions. There must be sufficient equity in the property to satisfy the first mortgage in full, and still pay at least some of the amount owed for the second mortgage. However, even if there is no foreclosure action, a second mortgage discharged in Chapter 7 must still be satisfied when the property is sold or refinanced.
A Chapter 7 discharge may provide valuable protection from personal liability for a mortgage that is no longer affordable. However, the Chapter 7 discharge will not prevent the loss of the debtor’s home in foreclosure.
The Bankruptcy Code does not require that mortgages be reaffirmed. Consequently, a lender cannot foreclose on the property for failure to reaffirm the mortgage. (Click here for more information about reaffirmation agreements). Because reaffirmation would reestablish the debtor’s personal liability for the mortgage, which would otherwise be discharged, it is almost never advisable to reaffirm a mortgage in Chapter 7.
Because the mortgage loan is discharged in Chapter 7, most lenders will report this fact to the credit reporting bureaus. That is, even though the debtor remains current with his or her mortgage payments after the bankruptcy filing, the lender will not report the mortgage as being paid. As a consequence, the debtor’s credit score, after bankruptcy, does not benefit from the timely payments.
One way to possibly have the payments reported after a Chapter 7 discharge, is to request a copy of your payment history from the lender. You can then dispute the credit report with each credit reporting bureau, attaching a copy of the payment history. When the credit bureau verifies the information, the lender would be forced to acknowledge that its payment history is accurate. This process would have to be repeated regularly, in order to keep the credit reports up to date.
If you already have a loan modification for your mortgage, then generally the same rules apply as for mortgages in Chapter 7. That is, your personal obligation under the modification agreement is discharged. Again, in order to prevent foreclosure, you must continue to make the payments as specified in your agreement.
However, the situation is different when debtors who have received a Chapter 7 discharge apply for a loan modification. Banks routinely deny requests for loan modifications after a Chapter 7 discharge, unless the loan has been reaffirmed. For this reason, if you are considering a Chapter 7 bankruptcy, but also need a loan modification of your mortgage, you should obtain the loan modification first, if possible.
There may be a downside to this strategy, however. For debtors who are over the state median income for their family size, the amount to be paid on a monthly basis for their mortgage is a deduction off of the “means test”. For certain debtors, reducing the amount to be paid for their mortgage may put them above the income limit for Chapter 7. In that case, the individual may have to file a Chapter 13 bankruptcy.
Anyone considering a Chapter 7 bankruptcy filing must take these issues into consideration if they are having difficulty paying their mortgage. It is important to consult with an experienced bankruptcy attorney who can guide you through the complexities that may arise in these situations.
Unlike in Chapter 7, mortgage debt is not discharged in Chapter 13, with certain exceptions. Section 1328(a)(1) of the Bankruptcy Code excepts from discharge any secured, or unsecured, debt for which the last payment is due after the date on which the final payment under the Chapter 13 plan is due. The maximum time period for a Chapter 13 plan is five years. So, unless the last payment for the mortgage is due within the five year period, the mortgage will not be discharged. Consequently, once the Chapter 13 case is closed, the debtor will continue to be personally liable for the mortgage loan.
The only other exceptions to this rule would be 1) if a subordinate mortgage lien was stripped, thereby making the loan an unsecured debt to be paid through the Chapter 13 plan; or 2) if a mortgage for property other than the debtor’s primary residence was “crammed down” and paid through the Chapter 13 plan. In either situation, the mortgage loan would be discharged in the Chapter 13 bankruptcy proceeding.
If you have a mortgage on your home, and are considering filing for bankruptcy, it is important to consult with an experienced bankruptcy attorney. Andrew M. Doktofsky will review your options with you to determine how best to proceed. Call (631) 673-9600 to schedule a free consultation.
Andrew M. Doktofsky serves clients throughout Long Island, including Huntington, Commack, Ronkonkoma, West Babylon, Northport, Lindenhurst, Massapequa, Hauppauge, Deer Park, West Islip, and elsewhere in Suffolk County and Nassau County.