There has been a lot of talk about whether or not homeowners should walk away from their mortgage lately, and we thought it would be helpful to write about how bankruptcy and walking away intersect.

It probably comes as no surprise that homeowners who are considering giving up their home are usually “underwater” with their mortgage, meaning that the home is worth less than what they owe. Desperate to keep their heads above water, many homeowners simply move out of their home and mail the keys to the bank. Before you take a step like this, consider the consequences and whether or not there are any alternatives.

First, defaulting on your mortgage will trigger a foreclosure sale. If the public trustee sells the home for less than what you owe, the result is that there is a “deficiency.” The deficiency is the difference between what you owe and what the house sold for. You can bet that the lender will want someone to pay the deficiency, and unfortunately, that someone is the homeowner who walked away.

Are there any alternatives to walking away from your mortgage? Yes, a couple. You could negotiate a “short sale” with your lender, where your lender agrees to let you sell your home for less than what you owe. Again, since you are obviously selling for less than you owe, you need to consider what the bank will do with the deficiency. The best course is to ask if the lender will agree to not pursue your for the deficiency. Their response can depend on many factors, so it is impossible to say whether or not they will agree.

Your other alternative is to consider filing Chapter 13 bankruptcy. Chapter 13 bankruptcy will allow you to “strip” and second or third mortgages. Keep in mind that you can only use this strategy as long as you owe more on the first mortgage than what the home is worth. Any other mortgages will be converted to unsecured debt through your Chapter 13 plan. You’ll pay your unsecured creditors based on a simple formula to calculate your disposable income. At the end of your plan any thing still owing to your unsecured creditors will be discharged, just like in Chapter 7 bankruptcy. What this means is that at the end of your Chapter 13 bankruptcy (which can last between three and five years), you’ll be left owing only your first mortgage. Also, Chapter 13 may not be an option if you can’t repay any back payments to the lender that you’ve missed during your bankruptcy.

Lastly, if you decide to walk away from your mortgage and the lender pursues you for the deficiency, the deficiency can be eliminated in either Chapter 7 or Chapter 13 bankruptcy. In some cases, this is the best way to be sure that the bank doesn’t come after you for any money you still owe.

If you are thinking about walking away from your mortgage, sit down for a free consultation with a Denver Bankruptcy Attorney to see if Chapter 7 or Chapter 13 bankruptcy is your best option. We’ll be glad to talk to you about the bankruptcy process and won’t hesitate to tell you if we don’t think it’s a good idea in your case.

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