Bankruptcy is a last-resort option to alleviate consumers from overwhelming debt obligations. While bankruptcy courts almost always discharge unsecured debts such as credit cards in a bankruptcy, your secured loans do not qualify for discharge without liquidation of the asset the loan is secured against. Similarly, a home equity loan acts as a second mortgage against your home and may not be eligible for discharge in bankruptcy.
There are two types of bankruptcy to choose from when you file. Chapter 7 bankruptcy is the most drastic option, as it requires you to liquidate most of your assets, and possibly your home, to repay your lenders before fully discharging your debt balances. On the other hand, Chapter 13 allows you to set up a repayment plan in which you pay back your debt in monthly installments that you can afford. The bankruptcy court then discharges any remaining balances after you complete your repayment plan.
Additionally, upon filing for bankruptcy, the court will impose an automatic stay on your residence that temporarily halts foreclosure proceedings in most circumstances to allow you to reorganize your late payments and resume regular payments. However, failing to maintain timely mortgage payments after bankruptcy will result in foreclosure.
A home equity loan is treated as a second mortgage against your home. As is such, the court sees the loan as secured by the value of your home, and your lender can foreclose on your property if you do not repay the debt. However, if you can prove to the bankruptcy court that your home's current value is less than the balance on your primary mortgage, the court can discharge the home equity loan as unsecured debt without risk of foreclosure.
If you are unable to discharge your home equity loan in bankruptcy, you must make regular payments on both your first and second mortgage to avoid foreclosure. Once you fall behind on your monthly mortgage payments, your lender will begin the foreclosure process to repossess your home and resell it or auction it to another buyer to recoup some of its costs.
If you are unable to make monthly mortgage payments even after filing for bankruptcy and wish to remain in your home, speak with your lender to discuss your options. You may be eligible for a loan modification or forbearance agreement that will allow you to stay in your home but lower your monthly payment obligations to a payment you can afford. If you cannot achieve an affordable modification, your lender may offer you the option to sell your home in a short sale or accept a deed-in-lieu-of-foreclosure agreement.
Short sales allow you the opportunity to sell your home for less than the balance of your mortgage, and your mortgage company will forgive the unpaid debt. A deed-in-lieu-of-foreclosure agreement allows you to voluntarily provide your lender with the deed to your property and walk away free and clear of mortgage debt. Both options avoid foreclosure. If you are unsure of the best option for you, speak with a free foreclosure avoidance counselor available through the U.S. Department of Housing and Urban Development.