Sep 18

The Discharge of Personal Liability to Pay a Mortgage in a Chapter 7 Bankruptcy

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What is the effect of a Chapter 7 bankruptcy discharge on a mortgage? What happens during the bankruptcy process in regard to the debt. In California the most common thing used to secure a loan when purchasing real estate it through a deed of trust. It is different than a mortgage because a mortgage actually places a lien against the property, but in a deed of trust scenario title to the property is really transferred to a trustee who is given the authority to sell the property if the debt is not paid. To accomplish the purchase several documents have to be executed the most important to the actual transaction being the Promissory note, which is the borrower’s personal written promise to pay back any loan take to purchase the property. The Deed, which is the document recorded to transfer title from the prior owner to the new owner, usually the person borrowing the money to purchase the real estate. And finally, the Deed of Trust which is the document that the borrower signs transferring the right to some third party to sell the property and pay the proceeds over to the lender if the borrower does not keep the promise to pay for the property as he or she said they would when the note was signed. The Promissory note is given to the person lending the money and the deed of trust and grant deed are recorded with the county recorder’s office. After recording the original grant deed is sent to the borrower who is the new owner of the real estate and the deed Of Trust is sent to the trustee named in the Deed of Trust to hold until the debt is paid. At the end of the transaction, the borrower should have the original grant deed, the lender should have the original note and the trustee identified in the deed of trust should have the original Deed Of Trust.

When things go wrong and the borrower cannot pay back the loan as agreed in the note and has filed a bankruptcy what happens to this debt. The bankruptcy code is very clear that the borrower’s personal responsibility to pay back the debt is discharged. That means the borrower no longer has a legal obligation to pay the debt back unless he or she or they have made a reaffirmation agreement with the lender and the bankruptcy court has approved that agreement after determining that the debtors can afford to make those payments. With no reaffirmation agreement, according to the United States Supreme Court as stated in Johnson v. Home State Bank, footnote 5, a bankruptcy discharge extinguishes the personal liability of the debtor with respect to any debt. This policy is so strong that a federal injunction arises against trying to enforce the debt against the debtor personally and should anyone try they are subject to contempt of court and semi criminal prosecution and punishment for doing so. The rub is that this applies only to seeking to get the debtor to pay back the debt personally. The problem is that when the debtor purchased the property he or she personally was not the only one liable on the debt. The property also became liable for repayment as a consequence of the mortgage lien or the deed of trust given at the time of purchase. So under bankruptcy law, the property remains responsible for paying back the lender. This is known as ”in rem” liability, and it can be sold to generate money to pay the obligation. This holds true for all different types of liens that can come up in the bankruptcy situation. Liens to secure the price of an automobile, or for loans taken giving the automobile as collateral, liens given to doctors or attorneys on the future recovery obtained in law suits, or any other type of lien that could be given to secure a loan or a promise, as long as the lien is valid.

The thing to remember is that successfully completing a bankruptcy extinguishes the bankruptcy petitioner’s personal liability on those debts, secured and unsecured, that he or she listed in the petition. The extinguishment is complete and can be enforced by contempt proceedings in federal court against anyone who does not respect and honor the discharge.

This blog simply contains my thoughts and ruminations on certain subjects. These are general impressions and are not intended to be taken as legal advice. If anything in this entry piques your interest or seems to apply to your situation please do not hesitate to contact us through our website at http://www.schinzelaw.com/ or directly by telephone at (760) 510-4900.

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