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Can the Bank Really Foreclose on a Property I Discharged During Bankruptcy?

Individuals file for bankruptcy in order to receive a fresh financial start. Chapter 7 bankruptcy provides debt relief for qualifying debtors by discharging, or cancelling, the majority of their debts by liquidating the debtor’s assets. Chapter 13, meanwhile, allows the debtor to pay off their debts under a specific plan over a period of time. Both types of individual bankruptcy filings permit certain types of exemptions, or assets that are exempt from being used to pay off creditors. The homestead exemption is one of the most frequently-used exemptions, permitting the debtor to keep their primary residence during and after the trying bankruptcy process.

However, there are some circumstances under which a debtor will be surprised to learn that a property that was declared either exempt or discharged during bankruptcy is now, sometimes years later, being foreclosed upon. So when can this happen? And how is this fair, when the point of bankruptcy is to give a person a fresh financial slate?

The Homestead Exemption

In Chapter 7 and 13 bankruptcies, individuals are allowed to keep property that is exempt by state or federal law. The North Carolina homestead exemption protects up to $35,000 in equity of any real or personal property used as a residence. The homestead exemption may be more depending on the debtor’s age and how the property is titled. For Chapter 7 cases, if the available homestead exemption does not cover all the equity in property that the individual owns, the property may have to be turned over to the Trustee to be sold. In a Chapter 13 individuals must pay their creditors an amount equal to the nonexempt portion of the property over the course of their Chapter 13 Plan term.

Even if a person exempts their home in bankruptcy, and the debt is discharged, they are still responsible for the mortgage payments on that home going forward. If the person falls behind on these payments and is unable to work out a means of making up the missed payments with their mortgage lender, they may still have to forfeit the property via foreclosure. Foreclosure is the legal process that a lender must use to take possession of property when the borrower fails to make the agreed upon mortgage payments. The filing of a bankruptcy case puts an injunction, called the automatic stay, into place which stops all collection activity, including foreclosures. The automatic stay remains in place while the bankruptcy case is pending. The mortgage lender may ask the judge to lift the stay while the bankruptcy is pending so that they can proceed with the foreclosure process or it may wait until the bankruptcy case is over to foreclose.

Once the automatic stay has been lifted or the bankruptcy case is closed, it is within the lender’s control at what point they take control of the property. Unfortunately, there can be a lag time of several years before the lending bank contacts the debtor with intent to foreclose, meaning the property will remain in the debtor’s name until that point. This means that the foreclosure action will appear on the debtor’s creditor report even though the property balance was discharged in bankruptcy. This negative reporting can put a hold on the debtor’s ability to be granted a new mortgage as many lending institutions will not authorize mortgages to individuals who have had a foreclosure sale or bankruptcy discharge within the last two or three years. Adding salt to the wound is the fact that the foreclosure process can take years—in many cases, four (4) and beyond. Ideally the debtor should be able to save some of the money they haven’t had to pay on the mortgage since discharging the property in bankruptcy, but this is not always possible. If you are being threatened with foreclosure because of nonpayment of mortgage loans post-bankruptcy, it is important to speak with an experienced bankruptcy attorney.

“Discharge” on Second-Mortgaged Homes

Debtors can also find themselves facing foreclosure after bankruptcy if they had previously taken out a second mortgage on their home, even if they were able to successfully claim the homestead exemption in bankruptcy. In home purchases where the buyer takes out a second mortgage, the buyer will have both a “first mortgage” that is for a fixed dollar amount, and a “home equity line of credit,” or HELOC for a line of credit up to a specified maximum amount. Like with a first mortgage, the debtor must continue making payments on their HELOC if they intend to keep the property.

A HELOC creates a lien on the property that cannot be discharged, or cancelled, in bankruptcy. What many people do not understand is that bankruptcy only prevents your home equity line of credit (or HELOC) from suing you or coming after you to pay on the loans. It does not prevent the HELOC lien holder from foreclosing on a home that was declared “discharged” during the bankruptcy. Thus, even though the is debtor no longer personally liable for the debt, the lender retains a lien against the property and is entitled to initiate foreclosure proceedings if the property owner fails to make the required HELOC payments.

HELOC lenders are not typically inclined to foreclose unless they stand to receive a substantial from the proceeds of the foreclosure sale. Because HELOCs usually come second to the first mortgage any proceeds from a foreclosure sale will be used to satisfy the outstanding obligation to the first mortgage lender, leaving anything remaining to the HELOC lender. The more equity a person has in a house, the more likely the lien holder will generally be to foreclose. In such a case, the only available option is frequently to attempt to negotiate the amount you owe with the HELOC lien holder. It is important to have the assistance of a qualified bankruptcy attorney if you are in this situation.

Contact Our Bankruptcy Attorneys Today to Schedule A Free Consultation

If you find yourself facing foreclosure on a debt you discharged in bankruptcy, or are ready to file for bankruptcy, it is crucial to speak with an experienced bankruptcy attorney. The bankruptcy process is long and complicated to begin with, and there are numerous instances where complications such as post-discharge foreclosure can arise. It is important to know your rights against creditors and have the dedicated representation of local counsel familiar with federal bankruptcy and local lending laws. With offices in Charlotte, Monroe, and Mooresville, the law firm of Arnold & Smith, PLLC handles bankruptcy cases for the Western District of North Carolina. Contact Arnold & Smith, PLLC today to set up a free initial consultation.