Foreclose or Declare Bankruptcy?

Clients in financial difficulty often ask whether they are better served allowing their home to go into foreclosure or whether bankruptcy might be a better option for them.

Not since the Great Depression have so many people had to learn so much about credit law. Five years ago most of the clients we now see in our offices thought foreclosures and bankruptcies happened to “other people” and now they’re coming up a steep learning curve for how to deal with the shifts in their financial well being.

Do you want to stay in your home?

If your mortgage payment is a burden that you cannot pay, it will eventually end in foreclosure. Everyone knows this. What most people don’t know is the role that bankruptcy can serve in helping them survive this brutal economy — sometimes in their own home.

While there are technicalities in the answer that’s best for each specific client (foreclose or declare bankruptcy), we generally find that it is rare that a prospective bankruptcy client has only a mortgage deficiency to worry about — there is usually other oppressive debt that makes a bankruptcy a logical way to get out from under debt and move on. Sometimes  bankruptcy protection enables families to stay in their homes.

The non-recourse mortgage

That said, if you do not want to seek bankruptcy protection,or want to pursue all other options first, find out whether the state in which you live allows non-recourse mortgages. North Carolina allows non-recourse mortgages, but does not require them. If you have a non-recourse mortgage, you might be able to negotiate a deed in lieu of foreclosure, where you simply give the home back to the bank and they would agree not to hold you responsible for any deficiencies on the loan.

You will have to look at your loan and mortgage documents to see which kind you have. Such an analysis is quite labor-intensive and thus usually costly – done on an hourly basis. We do not offer this service and don’t do it as part of a bankruptcy consultation.

Watch out for phantom income

Whether a lender can sue a debtor for the deficiency left after a foreclosure sale will depend upon the language in the loan and mortgage documents. In our experience, lenders have drafted around the statute so that they can sue if they want to. With a deficiency judgment, the lender would continue to pursue you to liquidate assets until the deficiency is satisfied. Moreover, if the lender did not pursue a deficiency, but rather “wrote off” the deficiency, the amount that the lender wrote off would be considered taxable income to you.

This is where bankruptcy comes in. With bankruptcy, a neutral party — the courts — decide which assets you may keep and what debts might either be written off or satisfied with partial payments over a period of time. When the courts protect you in this way, lenders may no longer seek payments above and beyond the court’s decision and in most cases you are not liable for “phantom income” as outlined above.

If you are in financial straits, call a bankruptcy attorney for a bankruptcy counseling session. Our firm will provide a no-obligation assessment for bankruptcy candidates. If you hire us to represent you, we will bill you for our services, but if you do not, you have a complimentary legal opinion.

Real estate, bankruptcy and credit laws are best sorted out by attorneys who have dedicated their professional lives to understanding and applying them. Call an experienced attorney in your area.