Upside Down Mortgage: Is Bankruptcy an Option?

Millions of homeowners are currently facing an upside down mortgage because the value of their homes has gone down as much as 30%-50% the last few years. Since homeowners have little or no equity, they have not been able to sell their homes and pay off their mortgage debt.

Lenders have had to foreclose on a record number of properties because borrowers defaulted on their mortgage payments and/or have decided to walk away. Some borrowers have been able to negotiate a resolution with their lenders and save their homes from foreclosure by qualifying for a loan modification, refinance or short sale under the HAMP and HAFA government programs. However, a large number of homeowners with financial hardships have filed for bankruptcy as a last resort. Upside down mortgage debt is dischargeable in bankruptcy after the property has gone through the foreclosure process and has been sold at a public foreclosure auction. If the auction sale proceeds are not enough to pay off the upside down mortgage debt, the remaining deficiency balance is dischargeable in the bankruptcy.

Chapter 7 or Chapter 13

Borrowers with an upside down mortgage have a choice of filing for either Chapter 7 Bankruptcy or Chapter 13 Bankruptcy. The following debts are not dischargeable in either type of bankruptcy: 

• State and federal taxes, with the exception that some federal taxes that are three years or older may be dischargeable
• Student loans
• Spousal support and child support
• Secured debts (excluding mortgages)

Chapter 7 discharges all other debts. Chapter 13 involves a scheduled repayment plan with your creditors. You should speak to a bankruptcy attorney before you file for bankruptcy. The Court will ultimately decide which bankruptcy you are qualified to file. You may be able to keep certain personal items such as jewelry, some cash in your bank account, your car and your home. There are statutory limits on the amounts and values of these items. You would have to exclude these items from discharge, and reaffirm any debt owed to your creditors by entering into a reaffirmation agreement with your creditors. You may keep your retirement and pension accounts such as an IRA or 401(k).   

Consult with an Attorney 

Bankruptcy is serious, and the bankruptcy laws are very complicated. It is recommended that you consult with a bankruptcy attorney before making a decision to file bankruptcy so you can find out all your legal options. A bankruptcy attorney can explain the bankruptcy procedures to you, and file your bankruptcy petition with the bankruptcy court.