Bankruptcy: What is it good for?

By way of disclaimer, I am not a Bankruptcy Attorney and do not even play one on TV (insert corny laugh track here). I practice in real estate law. However, as a practitioner in the area of real estate law, and someone who on a daily basis speaks with individuals contemplating how to address the debt on their home or homes, I am becoming more and more acutely aware of the trend to push folks towards Bankruptcy.

Now, make no mistake about it, the filing of Bankruptcy is a means to address all types of debt, including debt owed to lenders. It is a means of re-organizing debt and discharging debt under certain circumstances. But, in my opinion, if someone owns a home that is "underwater," it should not be their first option in addressing that problem. In fact, often times, it should be their last option.

There are several ways to deal with a distressed property (an "underwater property"). This includes allowing the home to go back to the lender through a Foreclosure/Trustee Sale, selling the property "short," modifying the loan or even what we call a Deed in Lieu of Foreclosure (issues we will deal with in subsequent blogs). And, there is also Bankruptcy.

The problem with Bankruptcy is because it provides debt relief, it also carries certain "ramifications". For instance, the Bankruptcy record stays on a persons credit for ten years. Further, once filed, a person cannot avail him or herself of the same protections for several years, depending on the type of Bankruptcy filed, when and how discharged.

As such, one should not run off to file Bankruptcy just to get rid of that pesky home loan.

In fact, we usually evaluate it this way: If the distressed property (the "underwater property") is removed or dealt with (eg sold in a "short sale') and the home owner is otherwise able to address any other debt and/or is financially solid or on the way to financial recovery, then bankruptcy is not an option. If, however, in addition to the underwater house, the homeowner is facing other issues, such as mounting credit card debt, loss of employment or financial issues - issues which make their entire portfolio unmanageable - then Bankruptcy could be an option.

In short, Bankruptcy should not be used solely to address an underwater home. It should be used to address a complete financial hardship.