Do You Have to Lose Your Home in Bankruptcy?

That was a question I was asked via email.

The answer is "No." You don't have to lose your home in bankruptcy. I've done loans for many clients who kept their homes through bankruptcy. But they kept their mortgage payments current, or close enough to current.

The condition that causes you to lose your property is called foreclosure. The specifics vary from state to state, but here in California, the lender has the option of marking you in default when you are 120 days in arrears on your mortgage.

Default causes you to lose some rights, and the lender to gain some. Since properties can go into arrears literally for years before they go into default, this seems appropriate. You could theoretically stay at 90 days behind throughout the whole term of your mortgage (except the first 90 days), and the lender can't really do too much about it except hit your credit. Please, don't try this at home. This is for purposes of hyperbolic illustration only. It really does kill your credit rating. Refinancing (or getting another loan after you sell) will be extremely difficult, and the rates will be sky high if you can get it.

But at the point you enter into default, your lender can require that you bring the loan completely current in order to get them to rescind the default. A Notice of Default, or NOD, is a matter of public record, and if one is recorded against your property, you can count on getting hundreds of solicitations from bankruptcy attorneys, hard money lenders, real estate agents, and just plain sharks. Additionally, the lender is going to hit you with thousands of dollars in fees when they put you into default. These go into what you owe.

Here in California, if you don't bring the loan current within sixty days, the lender has the option of dropping a Notice of Trustee's Sale on you. This publicly recorded document basically says "Bring it current now, or we're going to sell it at auction." Actually, at this point they can require you to pay them off in entirety to make them go away, and I don't know anyone except hard money lenders that will refinance you out of default. They can do this because you signed a Deed of Trust when you got the loan. Things are different in states that still use the mortgage system - there, the lenders have to go through the courts, which you're also going to end up paying for. The Notice of Trustee's Sale will tell the owner to be out at least five days prior to the auction. You also lose the legal right to redeem the loan at that point, although most lenders will keep working with you until the gavel falls. There must be a minimum of 17 days between Notice of Trustee's Sale and the actual auction. This is called foreclosure.

Bankruptcy is a different process entirely, and has to do with solvency, the ability to make required contractual payments on all of your debts. Within limits, you can choose to enter or not enter bankruptcy, and which creditors are and are not included in the bankruptcy. It's usually better not to include everything in the bankruptcy, because post bankruptcy credit history is critical re-establishing your credit. No matter what else, if you can stay current on the loan against your personal residence, that has more rights of preservation against other creditors than anything else (usually). Please consult an attorney in your state - there may be differences in the rules, or you may fall into one of the exceptions, and there are all kinds of relevant details I'm not going into here.

If you can hang onto your personal residence, and keep the loan current through bankruptcy, you not only (usually) get to keep your property, but you have a ready made mechanism to rebuild your credit. Those monthly payments you keep making to your mortgage lender? They count for credit re-establishment. In fact, if you have zero balance credit cards or revolving lines of credit, you can often choose not to include them in the bankruptcy, get to keep them, and all that nice jazz having to do with duration of credit, etcetera. You might want to read my article Credit Reports: What They Are and How They Work for more.

Foreclosure and bankruptcy are two different issues that often go together - but not necessarily. The law gives consumers a lot of protections on their primary residence, even through bankruptcy, but if you go into default on your mortgage, it's very hard to keep your home if you're in bankruptcy also.

I have seen people fresh out of Chapter 7 bankruptcy qualify for an A paper loan. It's unusual, but it does happen. What usually causes it to happen is that they have one or two lines of credit, often business related, and they file bankruptcy promptly, rather than spending months getting their credit dinged because they're in denial, and they keep everything else is current.

But if you keep your mortgage payments current, whatever else happens, frequently you will emerge from bankruptcy with your property.

Caveat Emptor