Many Americans currently considering bankruptcy are in financial trouble partly because of the struggling housing market. Underwater mortgages (those in which the homeowner owes more than the home’s current value) are a reality for as many as 28 percent of American homeowners.

Even though bankruptcy law prohibits the court from modifying the terms of a primary mortgage, some bankruptcy lawyers have found a legal way to help their clients stay in their home and avoid foreclosure.

Unsecured Second Mortgages

Here’s the process some bankruptcy petitioners are following to help ease their mortgage debt:

• File for Chapter 13 bankruptcy: Entering a Chapter 13 case means that the filer agrees to a three- to five-year repayment plan in which she will catch up on past-due debts.
• Petition the court to declare a second mortgage unsecured debt: Filers who have second mortgages that, combined with their primary mortgages, exceed the value of their home’s current value, may be able to make this move. A bankruptcy lawyer can explain in more detail how the move works and whether it might be possible in any individual’s case.
• Make payments according to the repayment plan: If the court accepts the petition, the filer must continue making payments according to her repayment plan for the duration of the bankruptcy case. At the end of the case, the remaining unsecured debt (including that from the second mortgage) may be excused by the court.
• Avoid foreclosure: In many cases, reclassifying a second mortgage as unsecured debt allows filers to make mortgage payments and remain in their homes.

The Winners and the Losers

Naturally, this legal maneuver is good news for struggling homeowners and potential bankruptcy filers. But banks and other lenders are apparently less than thrilled about the development – after all, they’re the ones who lose out on mortgage payments when debts are excused in court.

But, as one news outlet reminds us, the only way to change the law is an act of Congress. Given the current state of the American housing market and level of financial difficulty many Americans are facing, a move of that sort seems unlikely: what politician would want to be responsible for taking away a tool for avoiding foreclosure?

Can You Save Your Home from Foreclosure?

In order to take advantage of this legal protection, your financial situation must meet a number of criteria:

• Sufficient income to make payments: In order to benefit from Chapter 13, you have to be able to make monthly payments according to a repayment plan, which means you have to have a steady source of income.
• Two (or more) mortgages: Again, primary mortgages cannot be modified in bankruptcy court.
• An underwater home: Finally, you can only have debt declared unsecured if there is no property to secure it (that is, if your loan is worth more than your home). If your home value exceeds the amount of your primary mortgage, then at least a portion of the second mortgage is secured by the home, and cannot be excused by the court.

If you’re ready to find out whether this might work for you, connect with a bankruptcy lawyer today.

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