One way for a property owner to stop a foreclosure from going forward is to file some type of bankruptcy proceeding. Under Title 11, United States Code, Section 362(a), as soon as a bankruptcy proceeding is filed, an “automatic stay” goes into effect, which stops a foreclosure proceeding from going forward.

So far, this sounds like a good way to deal with a foreclosure. The problem is, bankruptcy is seldom a good long-term way to avoid foreclosure. There are different types of bankruptcy, each of which has its own issues.

The simplest form of bankruptcy is Chapter 7 liquidation. If a Chapter 7 is filed, then virtually all assets of the person filing the bankruptcy are handed over to a trustee, who liquidates them for the benefit of creditors. In the case of real property assets, if the property has equity, over and above the mortgage debt, then the trustee is likely to sell the property, and use the proceeds to pay unsecured creditors. If the property has no equity, then the Bankruptcy Court is likely to grant “relief from stay” and let the lender foreclose in fairly short order. In short, in Chapter 7, the person filing the bankruptcy usually loses his or her real property. Perhaps the only advantage of a Chapter 7, from the perspective of a property owner trying to save a property, is that it will wipe out his or her other debts, and thus leave him or her with more money to pay the mortgage on the property. Please note that, while a Chapter 7 wipes out (or discharges) virtually all debts, it does not release liens against real property. Thus, if a property owner files a Chapter 7, and receives a discharge, he or she is released of personal liability to the lender, but the mortgage lien against the property is not released.

Pretty much the only time that bankruptcy will actually save properties from foreclosure, long-term, is in a successful Chapter 11 business reorganization or Chapter 13 individual debt repayment case. Both types of proceedings offer the possibility of working out a plan to pay back the lender the defaults, over time. Both types of proceedings are complex, however, and relatively few of them are successful.

For a full discussion of bankruptcy law alternatives and issues, please see: