Bankruptcy is Relief From Debt
Its a very old idea that if someone is truly not able to pay their debts, they should be given a another chance instead of being harassed by creditors for the rest of their of lives. In the Bible, the Old Testament provides that debts are to be forgiven in the seventh year. When the United States Constitution was written, our founding fathers thought the right to file for Bankruptcy Relief was so important, they established Bankruptcy before even considering the freedom of speech or religion.
Bankruptcy is Protection
From the moment a Bankruptcy petition is clocked in at the courthouse there is an automatic injunction or "Stay" that goes into effect. From that moment, creditors must stop all attempts to collect from you. The Court will send out notices to all the creditors. Once a creditor is on notice that a bankruptcy has been filed, they must stop. They cannot sue you; if they have already filed suit, they must stop it. They cannot foreclose against your house, garnish wages, repossess cars, or even call you on the phone at home or at work. If they do, they are in contempt of Court.
Types of Bankruptcy
Chapter 7: Liquidation of Debt and Assets
In Chapter 7, all debts are discharged, meaning erased, except those that the person wishes to keep. If you want to keep your car, you have to keep their car payment. Likewise, if you want to keep their home, you have to keep their house payment. If a person is only a few months behind on their mortgage, chapter 7 can be used in a "work-out" situation. A chapter 7 can leave a person with only their basic living expenses. Other debts like credit cards, doctor bills, and even some taxes no longer need to be paid freeing up money to catch up with the mortgage payments. It is sometimes possible to enter into a " reaffirmation agreement" that modifies the terms of the mortgage and makes it more affordable. One thing a chapter 7 cannot do is force creditors into a repayment plan. So, if the mortgage payments are too far behind, and the lender doesn't want to deal, a chapter 13 would be a better option.
Chapter 13: Reorganization of debt
Chapter 13 is a reorganization of debt. Creditors are divided into groups including "secured" and "unsecured." A secured debt has collateral or security. On a car loan, the car is the security. If you don't make the payments the loan company can come and repossess the car. In the case of a mortgage, the house is the collateral. If you don't make the house payments, they can file foreclosure. Unsecured creditors include credit cards and doctor bills and have no collateral or security. In a chapter 13 case, regular payments must be made through the court to secured creditors if the person wants to keep the collateral, meaning the house or the car. If the person is behind in their payments, the amount they are behind is put into a payment plan and spread out up to 60 months. For example, if a family's regular mortgage payment is $2000, and they are five months behind, the arrearage is $10,000. In chapter 13, they would pay their regular payment of $2000 plus $167 per month (10,000 divided by 60 = 167). As long as they make the payments in the chapter 13 payment plan, the lender cannot foreclose.
Lien Stripping. It is also possible to eliminate the second mortgage if it has no equity. If the first mortgage is greater than the value, subsequent liens can be stripped because they no longer secured by equity.