Handling Home Equity Default After Bankruptcy

Home Equity Default After Bankruptcy

Many homeowners in bankruptcy have underwater mortgages along with home equity lines of credit (HELOCs) which may be dischargeable.  But what happens if after exiting bankruptcy a debtor fails to pay his/her HELOC?

Let’s take a look at a few facts:

Legal Responsibility

A debtor’s legal responsibility for HELOCs after bankruptcy is determined by one factor, a reaffirmation agreement. A reaffirmation agreement simply states that a debtor is responsible for paying a particular debt after the bankruptcy discharge. If a debtor signed a reaffirmation agreement for their home equity line of credit, then they are legally responsible for paying the debt despite their bankruptcy filing.

A bankruptcy debtor who signs a reaffirmation agreement for the HELOC can face foreclosure and a lawsuit if they default on their loan after bankruptcy.  On the other hand, if the bankruptcy debtor did not sign a reaffirmation agreement, they are not legally responsible for the HELOC; but they can still face foreclosure.  This means that the lender can seize the property; but they cannot sue the post-bankruptcy debtor for any deficiency balance.

Will The Lender Foreclose?

Foreclosure after bankruptcy due to non-payment is not always automatic, especially when it comes to HELOCs. If a bankruptcy debtor’s home is underwater, the home equity lender isn’t likely to foreclose because it often doesn’t make good business sense.  For example, if bankruptcy debtor’s home is worth $150,000 and they have a primary mortgage for $200,000 along with a $45,000 HELOC, if the junior mortgage (the HELOC) files foreclosure, they will need to pay off the primary lender before taking any profit for themselves. In this case, they wouldn’t receive anything because the home is worth significantly less than the primary mortgage.

So what will a HELOC lender do to get paid after bankruptcy?  Well, the first thing post-bankruptcy debtors should understand is that they cannot remain in a home without paying the mortgage whether or not they sign a reaffirmation agreement. Understanding that, what the home equity lender is likely to wait until the home increases in value before filing foreclosure.  For example, if that $150,000 house rises to a value of $250,000 by some miracle, the home equity lender will file foreclosure to get their money, if the debtor stops paying.

One other option is that the post-bankruptcy debtor can negotiate a settlement with the home equity lender to avoid foreclosure. This should be done with great caution. Remember, bankruptcy discharges your financial responsibility to the debt. And while the home equity lender can file foreclosure, it may be better to lose your home than to sign up for additional debt.