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Foreclosure Considerations in Bankruptcy

Prior to the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), directly upon filing for federal bankruptcy relief, the bankruptcy court would issue an “automatic stay.” The stay is essentially an injunction which prohibits a debtor’s creditors from pursuing further collection activities without permission of the court. Creditors who violate the automatic stay are subject to fines.

BAPCPA places limits on the automatic stay, effective October 17, 2005. When a debtor files more than one bankruptcy case, the stay is not automatic and is less protective than the stay effective in the first bankruptcy case filed. The stay in the second case is only effective for 30 days and will not go into effect at all in subsequent cases. In subsequent cases filed within one year, the debtor must request to have the stay implemented and establish that the subsequent cases were not filed in bad faith. While this provision of BAPCPA is designed to penalize debtors who file a series of bankruptcy cases to delay a foreclosure, it also applies to those debtors whose cases were dismissed due to a mistake.

Bankruptcy’s automatic stay provides a powerful tool for homeowners facing a foreclosure because it stops the lender or trustee from forcing the sale of their home. However, the automatic stay might only stop foreclosure proceedings temporarily, depending upon the type of bankruptcy that is filed.

The Automatic Stay Immediately Stops the Foreclosure

An individual who owns a home and falls behind in their mortgage payments to the lender faces an action of foreclosure by the lender. The lender, typically the bank, is entitled to force a sale of the collateral (the home) to satisfy the debt. One method, used as a last resort, to prevent or temporarily stall a home mortgage foreclosure is to file for relief in bankruptcy. While the automatic stay issued by a bankruptcy court will prevent an immediate foreclosure sale, it may only provide temporary relief.

Foreclosure Under Chapter 7 Bankruptcy

In Chapter 7 bankruptcy, the debtor is requesting that their dischargeable debts be completely “wiped out.” As such, a Chapter 7 debtor is required to turn over all of their non-exempt assets to a bankruptcy trustee. The trustee then liquidates, or sells those assets and divides the proceeds among the creditors of the debtor according to their priority. Most remaining debts are discharged. However, with regard to foreclosure actions, the automatic stay under Chapter 7 will typically only provide homeowners with temporary relief from forced sale.

Under BAPCPA, only those debtors whose incomes fall below the state median and are unable to pay $100 a month to creditors (determined not by the debtor’s actual income and expenses, but rather by IRS rules defining “reasonable” expenses) qualify for Chapter 7. Those unable to qualify for Chapter 7 may instead be forced to file for Chapter 13 bankruptcy which mandates a court approved repayment plan.

Relief from the Automatic Stay

In a Chapter 7 case, secured creditors, including mortgage lenders, can request that the automatic stay be lifted with respect to their interest. Generally, in seeking relief from the stay, the creditor must demonstrate that there is cause for lifting the stay. “Cause” is usually satisfied by a showing that the creditor’s interest is inadequately protected. This is often the case in Chapter 7 bankruptcy since the difference between the creditor’s interest in the home exceeds or barely exceeds the equity. If relief from stay is granted, the effect is to restore all of the original rights and liabilities between the parties, and the foreclosure may proceed.

Homestead Exemption Applied to Equity

Federal law and most states offer a homestead exemption. This is a dollar or acreage amount that the debtor is allowed to keep outside of bankruptcy and it is applied to their home equity. If the exemption amount is equal or almost equal to the home equity amount, the debtor may be able to save their home from foreclosure. Otherwise, where the debts against the home exceed the home’s value (including the applicable exemption), the debtor will likely lose their home to foreclosure.

As noted above, the dollar or acreage amount of the homestead exemption differs from state to state, with the exemption being far greater in some states than in others. Effective April 21, 2005, a cap of $125,000 applies to the homestead exemption for homeowners who have resided in a state for less than 40 months, regardless of the amount of the homestead exemption in that state. The state’s homestead exemption will apply to homeowners residing in that state for more than 40 months, even if the applicable homestead exemption exceeds $125,000.

Chapter 13 Bankruptcy in General

Under a Chapter 13 bankruptcy, the debtor is seeking to reorganize their debts in a manner by which they can pay them back over time. Since they are repaying all or most of their debts, Chapter 13 debtors are entitled to keep all of their assets, including their home. However, there are stricter eligibility requirements to file for Chapter 13. For instance, the debtor must have regular and stable income, and their secured and unsecured debts must meet specific statutory dollar amounts. In Chapter 13, the debtor formulates a plan of repayment which is then subject to approval by the bankruptcy court.

Foreclosure Under Chapter 13

As with a Chapter 7 bankruptcy, an automatic stay is immediately issued and effective upon filing for Chapter 13. The debtor will not lose their home in a foreclosure as long as their Chapter 13 plan provides to cure any existing default in the mortgage payments and to immediately resume making regular monthly payments. A Chapter 13 debtor is afforded a reasonable period of time to bring their mortgage up to date. Lenders are less likely to request relief from the stay since their debts are being provided for under the repayment plan. As such, Chapter 13 may prevent a debtor from losing their home in foreclosure.

Failure to Fulfill a Chapter 13 Plan

After the Chapter 13 plan is confirmed by the bankruptcy court, the court issues an Order Establishing Deadline for Making Payments. The debtor must begin making payments on the date specified in the court order and continue making monthly payments until the plan is successfully completed.

The enactment of BAPCPA made fulfillment of a Chapter 13 repayment plan potentially more difficult. Under BAPCPA, debtors are only allowed to claim “reasonable” expenses as determined by the IRS, not actual expenses. Thus, in areas with a high cost of living, the debtor wll only be allowed to keep the amount of income allowed for certain expenses, even if the actual expense is much higher. It is anticipated that many debtors will be unable to fulfill the repayment requirements of their Chapter 13 plan under BAPCPA.

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