Declaring bankruptcy can be a surprisingly effective tool for saving a home in foreclosure, sharply reducing the likelihood the property will go to a foreclosure auction, according to a recent study.

Lower-income borrowers who filed for bankruptcy after their homes were foreclosed on were 70 percent less likely lose their homes to a foreclosure auction than those who did not file, according to the study from the University of North Carolina's Center for Community Capital.

While both Chapter 7 and Chapter 13 bankruptcies automatically halt foreclosure proceedings while the case is pending, the study found that a Chapter 13 bankruptcy was the most effective at preserving home ownership during a foreclosure action, proving five times more effective than a Chapter 7 proceeding. The study's authors suggested that's because a Chapter 13 bankruptcy provides a mechanism for restructuring and repaying debts in a manner that eventually cures mortgage arrears.

At the same time, the study's authors note that a Chapter 7 bankruptcy can offer certain advantages related to forestalling a foreclosure, in that it eliminates unsecured debts such as credit card and medical bills, thereby freeing up funds that can then be used to pay the mortgage.

Few actually file

Despite the advantages bankruptcy offers borrowers seeking to protect their home, the study found that very few low-income borrowers - only 8 percent - actually filed for it after their homes went into foreclosure.

"What is surprising is that more people do not file for bankruptcy during foreclosure," the authors said. "One possible explanation is that the social stigma that surrounds bankruptcy deters many people from filing, possibly hastening the loss of their home."

The study looked at some 4,300 low-income borrowers who became seriously delinquent on their mortgages (90+ days late on payments) and had foreclosure proceedings initiated against them from 2003 to 2012.

Published on May 27, 2014