Dealing with your home when bankruptcy looms

November 23rd, 2008

Deciding to go bankrupt

For most people, bankruptcy is the final course of action in dealing with serious debt problems once all other alternatives have been exhausted.  Despite the negative connotation bankruptcy is an excellent solution because it immediately removes the burden of serious debt. However, the biggest potential loss when bankruptcy is declared is undoubtedly your home. That is, if you own a home. For most people their home is their largest and most significant asset. It is usually fear of this loss that prevents thousands of people from declaring bankruptcy when they should.  Many debt management companies exploit this fear in order to keep debtors in debt management plans which have no long-term benefit for the debtor. Of course, bankruptcy can never be an easy decision for anybody with financial problems; however, if it is the best option available to help a debtor regain their financial freedom then it should be pursued.

If bankruptcy is the only option available then, as a homeowner, they must sell their home and use any profits to reduce their debts before declaring bankruptcy. But what if the homeowner cannot sell his home? This is a situation that is very likely in our current housing market climate, yet a homeowner could simply hand over the keys to the mortgage company and move out. As we all know moving out like this represents the unthinkable for homeowners. If moving out in a financial crisis was that simple then many eviction companies would be out of business.

Now, if any homeowner is in this position they should be aware of the limited actions they can take to protect their property. Before I explain the options available in keeping and or staying in a property when declaring bankruptcy, it is important to understand what happens to a property in bankruptcy. 

The Impact on Property

When a homeowner declares bankruptcy, technically the ownership rights or the “title deeds” of the homeowner will be transferred to the courts/trustee. This simply means that the courts will automatically become the new owners of the property, therefore giving them the right to sell the home. It is the proceeds of any eventual sale that will be shared out amongst the creditors. However, before this happens there is a 12 month period of grace during which the bankrupt homeowner has the opportunity to  find a new home or salvage his home through a third party.

For a jointly owned property, where, for example, a male spouse is the only person declaring bankruptcy, it will be only his portion of ownership that is transferred in bankruptcy. The spouse’s partner is not technically affected with regard to her share of the home; however, she will be affected if the trustee decides to sell the house after the 12 month period of grace. The trustee can use the law to force a sale in order to cash in the spouse’s share of the property for his creditors.

Options for the homeowner

Because the main consequence of bankruptcy is the loss of highly valuable saleable assets, it is incredibly difficult to safeguard them. Therefore the two options I will proffer in helping you safeguard your property are weak however they could be advantageous, depending upon your situation. The first option is called the sale and rent back option. It is a very simple solution: you sell your property to an investor and then rent it back so you don’t have to move out and incur the extra cost of finding a new home. Again any profits from this deal should be used to reduce your debts. This solution should be pursued before you declare bankruptcy because it will be difficult to use this solution once you are bankrupt. The reason for this is because the value of the home at which you get this deal will usually be well below the market rate. The Trustee in bankruptcy cannot sell the bankrupt property below market rate because his interest is to get as much money as possible from the sale to satisfy creditors.

Another option is to ask the court when bankrupt to sell the property to a family member or a third party who has the resources to help you. This can help ensure that you stay in your home albeit with a different and or familiar owner. Therefore if the opportunity arises to buy back the property in the future, it will be possible. If you are thinking of transferring your house to family or friends before going bankrupt, forget it, because the bankruptcy laws give the trustee the power to look into gifts or assets transferred below market value. Assets transferred between 5- 7 years before declaring bankruptcy may be immune from this scrutiny, however, a recently transferred asset will sound alarm bells and raise suspicions that could lead to a criminal prosecution if it is discovered that you are not being completely truthful about your financial affairs.

I acknowledge that the solutions put forward are not guaranteeing foolproof protection for your home; however, one presents the opportunity of buying back your home in the future. The other also provides you with the choice of staying in your property rather than uprooting your family from your home and your children from their local schools. At the very least they provide the illusion that you still own your property.

12 Month Grace Period

Another question that might arise may be what happens if or when the 12 month period of grace elapses?  What if the property cannot be sold? In answer to the first question; the trustee will start to look for a preferred buyer, and if the property cannot be sold a charge will be put on the property until it is so, although it is important to note the that ownership can revert back to the bankrupt debtor after a certain number of years if it is not sold; however, this is very unlikely.

For any homeowner looking to declare bankruptcy, seek professional advice first. The action you take prior to declaring bankruptcy is extremely important, since it may help in speeding up the administration process and also help you when presenting your bankruptcy petition. Bankruptcy is not the end of the world but rather a way to clear away current financial problems and create the opportunity to start afresh. Therefore the sooner you take action and declare bankruptcy, the earlier you will be released from the burden of serious debt.

Paul Odunaiya is an insolvency specialist and the managing director of Qsolvency LTD, which trades as Paul has over 5 years’ experience in helping individuals and businesses in financial difficulties navigate their way out of serious debt.