Is Bankruptcy an Option?

How Chapter 7 could help if you can't afford your house.

By Pat Mertz Esswein, Associate Editor

From Kiplinger's Personal Finance magazine, February 2009

If you're trying to hold on to a house you really can't afford, you might consider filing Chapter 7 bankruptcy. If your petition is accepted by a bankruptcy court, your assets, including your house, would be sold to satisfy creditors but all debts would be discharged at the end. Then you could rent for two years and buy again in a saner market.

Stephen Elias, a bankruptcy lawyer and author of The Foreclosure Survival Guide and guides to bankruptcy, says this strategy buys you time and lets you save for your next move. Your home would go through foreclosure, but you could live in it mortgage-free throughout the foreclosure -- and even after it has been sold. In most states, the lender will have to legally evict you or pay you to get out.

Meanwhile, you can stash the money you don't pay on the mortgage in a savings account and use it to prepay your rent or make an extra-large security deposit to a skeptical landlord.

If you think your financial setback is temporary and that you will be able to afford your home later on, you could file for Chapter 13 bankruptcy to stop foreclosure and keep creditors at bay in the meantime. You'll have to propose to the bankruptcy court a plan to repay your debts -- your mortgage, plus a portion of any unsecured debt from, say, credit cards -- over the next three to five years. At the end of that time, any remaining unsecured obligations will disappear (except taxes, child support and student loans). That includes any home-equity debt other than your first mortgage that's not supported by the market value of your home.

Filing for Chapter 13 requires hiring a bankruptcy lawyer, which will cost you at least a few thousand dollars. Elias says that completing Chapter 13 requires a consistent income and the ability to stick to a budget. Information about accounts settled in a bankruptcy stays on your credit record for seven years, but the bankruptcy itself stays on your record for up to ten years. Barry Paperno, consumer-operations manager at Fair Isaac, creator of the FICO credit score, says that both types of bankruptcy will affect your score equally.

Also see, Fighting Foreclosure.

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