In Foreclosure, Should I File Chapter 13 or Chapter 7?
There are several different “chapters” of bankruptcy. Some are work-out others are wipe-out, but here is the general idea. When someone files bankruptcy it’s almost like someone builds a “bullet-proof” barrier around the house. No one can touch them! However they are not free of all responsibility and most people do not understand that.
The person who just filed bankruptcy appears before a judge who looks at their status and then determines what kind of monthly payments he or she needs to make to the bank. Usually banks have to agree to the terms set by the judge. The homeowner stays in his home under the guidelines of a bankruptcy and he has to pay the agreed amount to the bank.
Depending on if it’s Chapter 13 or Chapter 7, some or all “unsecured” debt is wiped out, homeowners can still keep their homes, cars, personal belongings, etc. Some assets you may be asked to sell. Bankruptcy will usually stay on an individuals credit report for 7-10 long years, and it will haunt them the whole time. Bankruptcy makes it very difficult to qualify for loans or purchases because of the derogatory marks on their credit.
As far as which one is better, Chapter 13 or Chapter 7 when going through foreclosure, it all depends. I’m not an attorney and every situation is different and homeowners needs are different. This is where a competent bankruptcy attorney will help you to determine which Chapter is better to file based on your needs and if you’re going through foreclosure and need the protection of a bankruptcy.
Difference Between Chapter 7 and Chapter 13
Chapter 7 is the “wipe out” and Chapter 13 is the “work out”. Bankruptcy is a federal court action designed to help individuals repay their debts or eliminate their debts depending on their circumstances. Chapter 13 bankruptcies are designed to reorganize debts in an effort to repay all debt. Chapter 7 bankruptcies are geared more towards liquidation of assets. Both Chapter 7 and Chapter 13 immediately stop the foreclosure process and any creditors from taking further action against an individual.
Chapter 7 Bankruptcy
When someone files a Chapter 7 bankruptcy, all assets are frozen. The attorney will create what is called an automatic stay. Everything “Stays” put. The homeowners can’t buy anything, they can’t sell anything, and they can’t even give away anything. If they try to sell their home, they couldn’t. If they try to give away savings, they can’t. Any unsecured debt like credit cards, unsecured loans, etc. are eliminated or wiped out. They do not exist anymore. Then the trustee or attorney who represents the court and the creditors will look at all the assets (house, car, furniture, equipment) anything of value and decide what must be liquidated to pay some of the debt that was wiped out.
If the homeowners are in the middle of foreclosure, a Chapter 7 will stop the foreclosure process. Obviously banks want their money so they will usually ask the trustee to release the property from the automatic stay so they may continue with the foreclosure process. Once the property has been released from the bankruptcy, the foreclosure process starts right where it left off. If the bank asks for this release, it is called an abandonment of asset.
So, now that you know banks can do this, did you ever wonder if you could do this? Yes, you can. But why would you ever want to encourage a bankruptcy? Sometimes you may be in a position where you need more time to work out a deal. If a person files a Chapter 7, it will buy you more time. Anywhere from 3-4 weeks more.
Note: You are not a financial advisor, don’t advise them to declare bankruptcy, just let them know this is an option. Let them make the decision and meet with an attorney.
The thing you should always remember when a Chapter 7 is filed, is that you can NEVER purchase anything or record anything while the property is in bankruptcy. If you do, you will be in serious trouble. You can still work with the homeowners, get all the paperwork filled out, just don’t record anything until after the bankruptcy has been discharged.
Chapter 13 Bankruptcy
Chapter 13 is a little different. When someone files a Chapter 13, they don’t take all the assets and sell them. Instead they take all the monthly payments from creditors and discount them for penny’s on the dollar. It’s like a debt consolidation plan. Whatever amount is agreed upon has to be paid to the bankruptcy count every month for the next 3-5 years. So the homeowners get to keep their house, their cars, and all their assets. Now, as long as the homeowner stays current with the mortgage payments and pays the amount agreed upon to creditors, they will be fine. However, if any payments are missed, the trustee will dismiss the bankruptcy.
If the person cannot pay the required amount set by the judge, then in 3 months the home will go back up for auction. Believe it or not, this happens all the time. So if one files bankruptcy, follow it or give the person your business card as a 2nd alternative if for some reason they fail to make their payments again.
If you come across a homeowner who has filed a Chapter 13 and want to work out a deal all you have to do is ask the trustee to release the home from bankruptcy so you can buy it. Remember, you can work with homeowners in bankruptcy, you just can’t record anything until after the bankruptcy has been discharged.
Hypothetically speaking, most homeowners who file bankruptcy are not in a great financial situation. Most will be able to make the scheduled payments for a few months and then they are back where they started. On average, those who file bankruptcy to prevent foreclosure end up going to foreclosure anyway because they have not changed their financial situation. So if you come across anyone who has filed Chapter 13 and thinks they will be ok, always offer your business card as an alternative option because more than likely they will call you.
[Note: Bankruptcy should be the last alternative or option and should not be used to stop foreclosure unless the homeowner has no other option or else they need the protection of a bankruptcy due to other circumstances or situations they currently are up against.]
How Bankruptcy Affects Credit Report
Bankruptcy usually affects credit reports in a really bad way. It will be a big negative mark on a persons credit for at least 7-10 years. For most it’s 10 years. Everything is tied to credit especially when borrowing. Your borrowing power will be affected for some time, however it won’t be affected forever. You’ll still be able to get credit cards and slowly work yourself to good standing again even after you file. It will feel like starting from scratch. Your credit limit might be $1000 and interest rate 30% because you are considered high risk.
If you show you can keep up with payments, every 6 months your credit card limits will increase giving you more borrowing power and increase your credit score. Eventually, you can even build your credit back to good standing and purchase a car or a home, even with a Bankruptcy on your credit. It may affect the interest rate is all. So yes, BK affects a persons credit in a bad way and won’t come off for 10 years, however, life will go on and over time you will still be able to buy most anything you were able to buy before and after 10 years that derogatory mark will fall off completely.