How does bankrutpcy affect my mortgage?

In the past two years, the value of residential real estate has dropped by an average of 30% or more nationwide. This leaves millions of homeowners with a house they owe more against than it is worth; they are "upside down" in the house. While the federal government has instituted some programs to help homeowners stay in their home and get their payments to what they can afford, sometimes it isn't enough to keep the house affordable. Can a bankruptcy help?

In general, unfortunately, a bankruptcy cannot help you change the terms of your first mortgage. The mortgage industry has a very powerful lobby, and has repeatedly defeated attempts to allow a bankruptcy to alter the terms of a mortgage. Every year, a congressperson proposes a bill that allows modifications in bankruptcy, and every year, it fails to make it out of the House of Representatives, let alone through the Senate.

All is not lost, however. Filing a bankruptcy can help you with your mortgage in several ways, and under certain circumstances:

• You can walk away from the home. Simply put, you can surrender the house to the mortgage company and leave it with no risk of a deficiency liability. This can be done in any chapter of bankruptcy. As a practical matter, it can be done outside of bankruptcy, and most mortgage companies will take the house and not pursue a deficiency. However, if you have a second mortgage, it may pursue a deficiency since it likely will get no money from a foreclosure sale. A bankruptcy will allow a free surrender no matter how many mortgages are on the house.
• If you have a second mortgage, a Chapter 13 bankruptcy may be able to get rid of it. If your home is worth less than what is owed on the first mortgage, it is possible to "strip the lien" of the second mortgage, turning it from a mortgage to a glorified credit card. This avenue requires some extra work by your attorney, and may necessitate a commercial appraisal of your home.
  
• The anti-modification provisions of the bankruptcy code do not apply to a mortgage that secures both the home and some other property. If your home loan is also secured by your car, personal items or another piece of real property, the lien can be "stripped" to the extent it is protected by home value. In this case, you can reduce the size of a second mortgage, and treat the rest like a credit card.

None of the above options is sufficient to keep most homeowners in their home if their mortgage is simply too expensive. For most people, walking away is really the only choice available to them. In my opinion, this is much worse than if a court is allowed to lower a mortgage's principal value to the market value of the house. Allowing that would keep more homes occupied, help adjust the real estate market, and in the end get mortgage companies more money. Until, however, the mortgage industry loosens its iron grip on Congress, that idea will remain the hope of attorneys like me.