This is the final installment of my six-part series on possible ways to deal with an “underwater” home.
Option #6: Bankruptcy
If you are drowning with an underwater mortgage, bankruptcy may help you get your head above the water – but it doesn’t always put you back on solid ground. “Bankruptcy by and large doesn’t solve the discrepancy between value (of the home) and debt. As long as it’s your home, the bankruptcy code prohibits the court from conforming the balance of the mortgage to the value of the home” warns Cathy Moran, a California-based consumer bankruptcy attorney. “That wasn’t always the case, but it has been for a long time and the efforts to change that died in Congress two years ago.”
What Moran is describing is the fact that mortgages on primary residences can’t be “crammed down,” or modified in bankruptcy so that the balance is in line with the value of the home.
Still, there are several ways that bankruptcy can help if your home is worth more than you owe:
- If you are behind on your home, a Chapter 13 can help you catch up on payments over five years without interest, “but that’s a remedy that’s independent of whether you are underwater,” notes Moran.
- A bankruptcy may halt a foreclosure long enough to get a loan modification considered. “And if the lender is willing to modify the terms you may be able to stay in the property by reason of the loan modification,” Moran says.
- Your home equity loan may be “stripped off.” If the value of your home is less than that of the first mortgage, then the second mortgage or home equity loan is essentially an unsecured loan that may be discharged in bankruptcy.
- You may be able to reduce or eliminate other debts, freeing up more money to pay toward the home mortgage so you can get back to positive equity more quickly.
- A deficiency judgment resulting from a short sale or foreclosure may be dischargeable.
Debts discharged in bankruptcy are not taxable the way other forgiven debt may be, but the timing here can be tricky. If you may owe taxes on forgiven debt resulting from a mortgage foreclosure or short sale, it’s vital that you talk with a bankruptcy attorney before the foreclosure or short sale is completed.
Chapter 7 bankruptcy (straight bankruptcy) remains on your credit reports for ten years from the date you file. Chapter 13 bankruptcies are removed seven years from the filing date. Bankruptcy has a significant impact on your credit scores, but so does foreclosure.