A Bankruptcy Doesn’t Get Rid of Your House

I frequently talk with people who think that by filing a bankruptcy, they can rid themselves of a house they don’t want anymore. Unfortunately, this is not the case.

In the modern housing crisis, there are many people who do not want to keep an over-encumbered house. They may have lost a job and know they will never be able to pay for it, or their efforts to obtain a loan modification may have been frustrating and ineffectual, and they are just tired of fighting to keep the house. So, the logical next question is, how can I give my house back to the bank? The short answer is, you can’t . . . unless the bank agrees.

(Note: I am using the term bank here loosely. Yes, I know that almost all residential loans are handled by a servicer, not by the holder of the note.)

Often, these people need to file a bankruptcy anyway and they think that the bankruptcy can help them deal with the house they want to dump. Here comes the confusing part: they are partly right and partly wrong. The bankruptcy discharges the personal liability on the debt, i.e., the bank could not sue you and get a money judgment against you personally. However, the bankruptcy does not cause the property to be transferred from you to the bank. And this can be a big problem for several reasons.

As long as the property is in your name, you are responsible for everything that happens on the property. So, you have to keep the insurance and property taxes current, and you have to make sure that the property complies with all codes and ordinances, e.g., making sure the grass is watered. Also, if your home has a property owners’ association, you are liable for any post-petition fees or assessments. This may be why it seems like banks are slower to foreclose on houses with property owners’ associations.

So, what has to happen to have the property transferred out of your name? There are several ways that could happen when the property is “under water”:

1. Deed in lieu of foreclosure. Sometimes, the bank is willing to take a deed in lieu of foreclosure. Essentially, the borrower signs a deed to the bank. Unfortunately, the bank usually requires a laundry list of guarantees to do this, and even then, few banks will actually approve these. Banks want to get the property sold and quickly out of the bank’s name, not keep it around in the bank’s name.

2. Short sale. A short sale means selling your property for less than the bank is owed. To do that, the bank has to agree. Getting bank approval can take a long time and they may not agree to it. There are also issues with potential tax consequences from doing a short sale. Once escrow closes, the property is no longer in the borrower’s name.

3. Trustee’s Sale a.k.a. Foreclosure. The foreclosure process takes a minimum of 110 days, but usually longer. First, the bank records and sends out a Notice of Default, giving the borrower 90 days to bring the loan current. If the loan is not brought current, the bank can then give 20 days notice of a trustee’s sale. At the trustee’s sale, the property is equitably transferred to the new owner, but it is not finalized until a trustee’s deed is recorded. Usually, the trustee’s sale deed is recorded within 15 days of the trustee’s sale. It is probably not safe to consider the property to have left the borrowers name until the trustee’s deed is recorded.

In bankruptcy, we might say that the “debtor intends to surrender the house.” But all that means is that the debtor will not be contesting a foreclosure. The bank still has to complete the foreclosure for the property to be transferred out of the debtor’s name. And sometimes, it takes a long time.

I have had many clients who have told me that the bank took over 2 years to foreclose on a home. Consequently, I usually suggest that clients not move out of a home until they know the lender will foreclose. That way, the client can make sure the property is kept up and taken care of while waiting for the lender to foreclose. Of course, the client won’t have to pay any rent during that time period and can save up for moving costs.