Understanding What Happens to Your Mortgage when You Declare Bankruptcy

When an individual or a family starts to have trouble paying monthly mortgage payments and encounters general financial challenges, some may wonder whether it’s an option to declare bankruptcy and how this financial strategy will affect their economic future. When all of a person’s finances are threatened, bankruptcy can be a way to mediate loss and do damage control in a tough time. Knowing more about how the bankruptcy would affect property holdings can help consumers plan for the aftereffects of this financial option.

General Rules on Mortgage Loans in Bankruptcy

Finance professionals will be quick to tell inquiring homeowners that all of the 50 states in the U.S. have their own separate rules on how to handle mortgages during bankruptcy. With that said, there are some general principles that hold true for most of the U.S. housing market. One of these ideas is that mortgages are not treated the same as other kinds of debt.

With credit card debt and other types of unsecured debt (debt that is not tied to a collateral), bankruptcy can be an effective way to get out from under the demands of creditors. Other kinds of debt, like mortgages, may not work the same way, and some of these may remain in place despite the nature of a bankruptcy.

Reaffirming a Mortgage or Loan

In the financial community, people use the word “reaffirmation” to refer to maintaining a loan through a period of bankruptcy. The idea is that those who are going through bankruptcy can reaffirm loans in order to make sure they do not get written off during the bankruptcy process if the individuals want to continue to hold the collateral and pay off the loan.

Reaffirmation seems like a way to keep a mortgage in place during bankruptcy in order to stay in a home, but some financial experts say reaffirmation really isn’t even necessary. They point to clauses in a lending contract that specify that a mortgage may stay in place despite bankruptcy, even though the paperwork around the mortgage may be different. In these kinds of situations, consumers learn that mortgages are extremely enduring contracts that may not just go away when an individual declares bankruptcy.

Those who need to default on a mortgage have various options, including a short sale for property and a deed in lieu of foreclosure where the borrower simply sells the title back to the lender. It’s worth noting that, depending on a certain loan to value, or LtV ratio, a borrower who sells the property back may still be left with some debt to pay off.

Families who are facing foreclosure and bankruptcy can read up on the relevant rules and regulations to determine how some kind of financial reorganization may work out in their favor. Although a bankruptcy can be effective in some situations, it is not a panacea, and some consumers may not really understand all of their options. Financial professionals can assist an individual or family in figuring out the best applicable options for dealing with loss of income and other financial challenges.