My Bankruptcy Lawyer Said All My Debts Were Discharged, So Why Is The Mortgage Company Trying To Foreclose On My Home?

by Jason Ostendorf on Jul. 08, 2012

Bankruptcy & Debt Bankruptcy Real Estate  Foreclosure 

Summary: Although a Chapter 7 discharge gives you a financial fresh start by wiping away your mortgage debt, it does not eliminate the lender's security interest in your home.

A common question bankruptcy lawyers often hear is, "What happens to my home if I get a Chapter 7 discharge?"  The answer is that it depends on whether you choose to continue making your mortgage payments.

A Chapter 7 discharge erases most of your debts.  There are some exceptions, such as student loans.  Fortunately, the mortgage is not one of those exceptions.  However, just because the mortgage debt is erased does not mean that the lender is not entitled to foreclose on the home.

A mortgage is made of two documents - a promissory note and a deed of trust.  The promissory note is the document that creates and sets the terms for the loan the lender gives you to buy a home.  In other words, the promissory note creates the debt.  The deed of trust, on the other hand, is the document that designates the home as collateral.  This is what makes the debt "secured" - if the debt is not repaid, whether due to bankruptcy or other reasons, the deed of trust allows the lender to take the home in an effort to cut its losses.

This dichotomy can be confusing, at times even for some foreclosure lawyers.  It does not help that the deed of trust names a third party - the trustee or holder of the promissory note - and refers to other parties who may be assigned rights in connection with the mortgage - such as the mortgage servicer or bank to whom the homeowner actually sends the monthly mortgage payments.  Nevertheless, the big picture is fairly straightforward - the lender gives you money only because it can be assured that it will not lose too much money if you fail to repay the loan (i.e., if you default, the lender gets the home so it can then sell the home for cash).

So, if you receive a Chapter 7 discharge, do you have to repay the mortgage?  No.  But, if you do not work out a payment plan with the lender, can the bank still foreclose on the home?  Yes.

There is a very good reason for all this.  If people could essentially get a free home by declaring bankruptcy, then everyone would do it.  Lenders would catch-on quickly and stop making loans.  Without loans, people would be unable to buy homes.  Along with banks (and therefore pensions, 401 Ks, etc.), the housing market would collapse.  Home builders, developers, pension fund managers, bank employees, and even the little guys (i.e., the IT professionals and other service providers who depend on servicing big corporations) all would go out of business.  It would make the Great Depression of the 1930's look like a golden age.

In sum, a bankruptcy discharges your debts, but does not give you a free home.  Regardless of what type of discharge you obtain, once the automatic stay is lifted, the bank will be legally entitled to foreclose on the home if the debt is not repaid.

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