Understanding How Bankruptcy Impacts Mortgage Foreclosure
The world of personal finance can be a labyrinth of complex terms and processes. In this comprehensive guide, we will navigate the uncharted waters of bankruptcy and mortgage foreclosure, two terms that often stir anxiety among homeowners. We’ll dissect the differences between these legal proceedings, discuss how they can impact your homeownership, and explore if bankruptcy can prevent a foreclosure or restrict your mortgage lender from confiscating your property.
Understanding the Types of Debt
Before we dive into the specifics of bankruptcy and foreclosure, it is fundamental to understand the difference between secured and unsecured debt.
An unsecured debt is a type of obligation where no collateral is backing your debt, like a credit card. If you fail to meet your payment obligations for an unsecured debt, your lender can assign or sell your account to a collection agency, who will then attempt to collect the debt. While these agencies can sue and garnish your wages, they lack the legal rights to repossess your assets.
On the other hand, secured debts are backed by an asset, meaning if you default on your loan, your lender can seize the collateral. Mortgages fall under this category, where your house acts as collateral and provides assurance to the lender in case of default. If you fail to pay your mortgage, the mortgage lender can foreclose on your home.
The Process of Mortgage Foreclosure in Canada
Foreclosure is a legal process that comes into play when a mortgage borrower fails to make their payments. The lender can take legal action and sue the borrower, and if the court concurs, the lender can assume ownership of the property.
Foreclosure results in the full transfer of property ownership to the mortgage lender, and the borrower forfeits all rights to the property, including any built-up equity. Once the lender forecloses the property, they gain complete control over it, with the freedom to rent, repair, or sell it.
Foreclosure is a costly and time-consuming process. The lender initiates the process by filing a Statement of Claim with the court. The borrower then has 20 days to respond with a defense. If the borrower fails to respond within this period, their mortgage may be declared in default. Subsequently, the lender will request a foreclosure order.
The court can issue a Redemption Order if it believes the borrower can catch up on their mortgage payments. This order provides the borrower with a specified time to pay off their mortgage and halt the foreclosure process. Usually, this period lasts for six months.
However, this period can be extended or shortened based on requests from the borrower and the lender, respectively. If the court can find a solution that allows the borrower to retain their home and the lender to recoup their money, they will opt for that route.
How Bankruptcy Can Help
Although bankruptcy proceedings do not directly deal with secured debt and cannot legally halt a foreclosure order, they can serve as a proactive measure to eliminate other debt and improve your cash flow. This financial relief may enable you to catch up on your mortgage payments.
Declaring bankruptcy does not necessarily mean you have to lose your home. If you can maintain your mortgage payments, Canadian bankruptcy law safeguards you. The law states that a secured lender, like your mortgage holder, cannot cancel your loan just because you’ve declared bankruptcy or filed a consumer proposal.
However, in any bankruptcy proceedings, you must address any non-exempt equity in your home. For instance, in Ontario, if the equity in your home exceeds $10,000, you must arrange to pay the equivalent amount to your Licensed Insolvency Trustee to keep your house. These rules vary by province, so it is crucial to consult with a Licensed Insolvency Trustee about your situation.
Foreclosure Versus Power of Sale
Foreclosure results in the lender obtaining legal ownership of the property, meaning any profits or equity from the sale go to the lender. However, the foreclosure process does not give the lender the right to sue for any shortfall. Consequently, foreclosures are quite rare in Canada due to this inability to sue for a shortfall and the lengthy, expensive process involved.
A more common process in Canada to collect on mortgage arrears is a power of sale, where the lender seeks court permission to evict you from the property and then sell it. Unlike foreclosure, the lender does not own the property title; instead, the court grants the lender the “power” to sell the property.
The financial outcomes for the homeowner in a power of sale versus foreclosure differ significantly. In foreclosure, any profits go to the lender, but in a power of sale, any leftover money after repaying the mortgage and costs is returned to the homeowner. Conversely, a lender has no recourse under foreclosure but maintains the right to sue the borrower in a power of sale scenario.
Bankruptcy and Mortgage Shortfall
When you declare bankruptcy in Canada, and your mortgage is underwater, the difference between the mortgage balance and sale value becomes an unsecured debt. You are not required to pay the difference between what you owe and what the home is worth if you surrender your home in a bankruptcy or consumer proposal.
Most shortfalls involve insured mortgages, which include high ratio mortgages. In such cases, it is usually the mortgage insurer (CMHC or Genworth) that will pursue you. They can seize tax refunds to recoup their money, which is why it is crucial not to delay and seek help.
Options for Mortgage Arrears
If you have fallen behind on mortgage payments, several options can help you manage the financial consequences of foreclosure.
Request a payment deferral:
This option has been widely used during the COVID-19 pandemic, but lenders have been granting short-term deferrals or mortgage extensions in extenuating circumstances for a long time.
Renegotiate the mortgage:
If you have a 15-year amortization, the lender may agree to restructure your mortgage under a 25-year amortization and include all arrears in the new mortgage. This structuring would eliminate your arrears and lower your monthly mortgage payment.
Find a new lender:
If your current lender won’t renegotiate, you can consider finding a new mortgage lender. However, be aware that private mortgages come with higher interest rates due to the added risk.
Sell the house yourself:
You may receive a better price than your lender, and if you expect positive equity after the sale, you can retain any potential capital gains for yourself.
File a consumer proposal and keep your home:
If your other debts are making it difficult to keep up with your mortgage payments, filing a bankruptcy or consumer proposal before foreclosure can help you manage your finances and make homeownership more sustainable.
Walk away and let the bank take possession:
Sometimes, it might be in your best interest to surrender your house before foreclosure and let the bank file an unsecured claim in your bankruptcy or proposal.
If you’re struggling with debt, it would be best to explore various debt relief options. Bankruptcy is one solution, but it’s not the only one.
