Borrower filing bankruptcy...what happens?

[Erick V.]

What would happen if after you buy a NPN, the borrower decides to file for bankruptcy? What happens to you as the note holder? I assume if the borrower throws the property into the bankruptcy that it would go to the note holder but what if the judge grants the borrower to keep the property. What options do they give the borrower in regards to the note?

[Dion DePaoli]

Just to clear up some concepts. Bankruptcy includes Chapters 7, 13 and 11 however 11 are not all that common. In the petition, the borrower either reaffirm the debt which means they agree they owe $X and will make payments moving forward or they surrender the property to the plan, which the Trustee can work to liquidate and pay creditors. This still has it's own barriers since title is encumbered and the sale will need to deliver clear and marketable title to a new buyer.

When Bankruptcy is filed an automatic stay of collection occurs for all creditors, secured and unsecured and the borrower is protected under Bankruptcy law during the BK plan. This means there is a very limited amount of contact a creditor (in mortgages that would likely be a mortgage servicer) can make.

If the borrower reaffirms the debt, they must make payments which can happen through or on top of the Trustee payment plan. Failure from the borrower (not the Trustee) to make the future scheduled payments are grounds for the creditor to seek Relief from the Stay of Bankruptcy. This essentially allows the Mortgagee to return to normal collection activity which may include foreclosure actions.

The Bankruptcy Plan can and does from time to time 'Cram Down' the mortgage debt. This takes place when the debt exceeds the value of the collateral. The cram down will retain the amount that is secured and any negative equity has to be moved into the Bankruptcy plan and must be paid through the plan. As you may imagine, this in most cases would create a type of balloon payment at the end of the BK plan or increases the payment required through the plan to a level not attainable by the borrower, so it has it's own barriers.

A properly discharged mortgage debt relieves the borrower of deficiency but does not 'cancel' or remove the mortgage from the property. So once a bankruptcy plan is complete and the debt is discharged, the borrower can still loose the property through foreclosure for default or other breach of contract. A normal foreclosure process must still take place. If the borrower fails to follow the plan, the BK plan is dismissed and the creditors can file and continue with legal collection means.

Due to some state laws in bankruptcy and mortgage foreclosure alternatives, yes a BK plan can force a Mortgagee to consider a modification. Forcing a consideration is not the same as forcing a final outcome.