Bankruptcy can even help you save your home, especially with home values down and so many mortgages underwater. You're allowed to keep a limited amount of home equity in most states. If the house is worth less than the mortgage plus your home-equity exemption, you can file for Chapter 7 bankruptcy, wipe out your consumer debts and still keep your home, provided that your mortgage payments are up to date, says Stephen Elias, a California bankruptcy attorney and coauthor of Nolo Press's do-it-yourself bankruptcy books. If your house is worth more, however, or you're behind on your payments, it will likely be sold.

When you're behind on the mortgage but have a new job with money coming in, choose a Chapter 13 workout. Your lawyer will negotiate a three- to five-year plan for paying your debts, including the mortgage arrears. Some people stay in the plan just long enough to get current on their mortgage and then resume their normal lives, Porter says. The next Congress may sweeten Chapter 13 by allowing a judge to reduce (or "cram down") your mortgage principal if the debt amounts to more than the house is worth. That would save a lot of homes.

Don't try to preserve your house if you're going broke. Stop making payments, stay there while foreclosure is underway, then move out and rent. If the mortgage is underwater, "you're already functionally renting because you have no equity," says Adam Levitin, a professor at Georgetown University Law Center. In theory, many states allow lenders to chase you for the sum still owed after the house is sold. But that's rare, Warren says. Lenders know that you probably can't pay.

Foreclosures stay on your record for seven years and bankruptcies for 10. If you re-establish good bill-paying habits, you may get decent credit even sooner. And you'll start fresh, which is what a new year ought to bring.

Reporter Associate: Temma Ehrenfeld

© 2009