Understanding A Mortgage and A Promissory Note

Understanding the effect of Chapter 7 bankruptcy on your mortgage starts with understanding that your home mortgage has two parts. The first part is the mortgage note, or promissory note, which expresses your personal obligation and liability to repay the mortgage bank all the money, with interest, the bank gave you because you were buying a home or owned a home with equity. It does not matter when and why the bank made you a mortgage loan. Some mortgage loans were used to buy a house, other mortgage loans are made for home improvement or expansion, and other mortgage loans are made as general lines of credit which you may use for any purpose. In all cases, the bank loaned you money and you are personally obligated to repay. The repayment of a mortgage loan is expressed in a mortgage note which is similar to any other enforceable promissory note from a borrower to a lender.

The second part of a mortgage loan is the mortgage deed, or the mortgage instrument. The mortgage deed (which technically is “the mortgage”) is a security instrument. The mortgage grants the lender a lien, or security interest, in your real estate to secure and guarantee your repayment of the underlying promissory note. The mortgage document includes the legal description of the property pledged for security and a description of the promissory note the mortgage secures.

A foreclosure proceeding is directed against the mortgage itself and note the note. A foreclosure judgment directs the court to liquidate (sell) the property secured by the mortgage. The proceeds from a mortgage sale, or the value of the property taken back by the bank, is applied to pay the underlying note. If the note is not paid in full from the sale or repossession of the property, the borrower remains liable under the underlying promissory note to pay the balance.

Chapter 7′s Effect On the Promissory Note

The mortgage note, the promissory note secured by the mortgage, is a dischargeable debt in bankruptcy. Your bankruptcy discharge will wipe out your personal obligation to repay any balance of principal and interest that you owe the mortgage lender under the terms of the mortgage note. That means if a mortgage lender forecloses the mortgage the lender cannot pursue collection of the promissory note, and any attempt by the lender to collect money due under the note will violate the bankruptcy stay and the bankruptcy discharge.

Chapter 7′s Effect On the Mortgage

Chapter 7′s effect on your mortgage security depends upon whether the mortgage is a first mortgage or a second (or junior) mortgage. Chapter 7 bankruptcy cannot change the terms of your first mortgage. Chapter 7 bankruptcy cannot cram down the mortgage balance, cannot modify the interest rate or monthly payment, and cannot strip the mortgage. If you do not pay your mortgage the lender can foreclose the first mortgage. So, even though a Chapter 7 bankruptcy discharges personal liability under the mortgage note the bankruptcy does not relieve you of the obligation to keep the first mortgage current if you want to keep your house.

If you fall behind on mortgage payments and then file Chapter 7 the bankruptcy stay will temporarily halt the bank’s collection and foreclosure. However, the bank will apply for, and in most cases the court will grant, a relief from the bankruptcy stay so that the bank may continue foreclosure. Chapter 7 may interrupt a foreclosure, but it does not stop a foreclosure and will not give the debtor a permanent relief from a foreclosure. What Chapter 7 does accomplish is preventing the mortgage lender from pursuing a deficiency judgment against you personally after a foreclosure has occurred.

Chapter 7 may provide homeowners help with their second mortgage. If you have a first and a second mortgage, and your home at the time you file Chapter 7 bankruptcy is worth less than the then current balance of the first mortgage, the Chapter 7 can strip off the second mortgage from your home. Chapter 7 debtors who are upside down as to their first mortgage may emerge from Chapter 7 with only a first mortgage lien and no personal liability either to the first mortgage lender or the second mortgage lender. If your home is worth $1.00 more than the first mortgage balance you may not strip off all or any part of your second mortgage. The Chapter 7 mortgage strip applies only to your primary residence.

What Should You Do In Your Chapter 7 Bankruptcy?

If you do not care about keeping your primary home then stop paying all mortgages. The bank will foreclose but they cannot come after you for money.

If you want to keep your home and have only a first mortgage loan then you must keep your first mortgage current. If you get in trouble with your first mortgage your bankruptcy attorney cannot help you unless you decide to convert to a Chapter 13.

If you want to keep your home and you have a first and a second mortgage, then you can stip away the second mortgage if the home’s fair market value is under the first mortgage balance. If the home is worth more the first mortgage you must keep both mortgages current to stay in your home.

The above options are only a general summary of your mortgage choices in a Chapter 7 bankruptcy. You must discuss your mortgage situation and options with your own bankruptcy attorney.

Jon Alper

About Jon Alper

Jon is an attorney focusing on bankruptcy and asset protection in Orlando, Florida.