Who Owns Your Home After Bankruptcy?

The law is an indecipherable mess to most people. Bankruptcy law is no different, and the relationship between federal and state law can create some frustrating situations. Take, for instance, the legal situation after a homeowner surrenders a home in bankruptcy. Common sense dictates that when a bankruptcy debtor moves out, turns the keys over to the lender, and discharges his personal obligation in bankruptcy, the home belongs to the lender, right?

Not exactly.

While the debtor discharged his personal obligation to pay for the home, the title to the home usually stays with the debtor. Let me explain. For home mortgages, there are two basic legal theories of ownership: lien theory and title theory. Under lien theory, a borrower owns title to the home despite the outstanding mortgage obligation. The borrower holds the deed while he makes payments to the bank and is considered the home’s owner, while the bank retains a security interest. Consequently, in lien theory states the bank has a more difficult time foreclosing on the homeowner and judicial oversight is usually required.

For a title theory state, the borrower is given the home deed “in trust” to hold while he makes payments. In fact, the document that the borrower receives is unusually entitled “Deed in Trust.” In a title theory state, the borrower doesn’t actually own the home until the mortgage has been paid and the lender releases the deed. Title states usually allow nonjudicial foreclosure because the home is technically owned by the bank. All the homeowner has is a right to receive the title after payments have been made, much like a watch pawned at a pawnshop.

While it seems that it should be easy for a debtor to surrender the home and transfer title to the lender during the bankruptcy case, there is no clear-cut way to do this. In theory, a title theory lender already owns your house and all you have is the right to get it back (called the right of redemption). Once this right is given up, there is nothing to foreclose. The lender is now the owner and you no longer have a legal right or obligation to the home.

Courts across the nation have said that the Bankruptcy Code does not require a lender to act upon the surrender of collateral in a bankruptcy. Until the lender is the legal and equitable owner of the property, the debtor may be on the hook for HOA (home owner association) fees, taxes, or property insurance. In a lien theory case out of Indiana, one court said that not even a quit claim deed unilaterally executed by the homeowner to the lender is enough to transfer title. See Phillips v. City of South Bend, 2007 Bankr. LEXIS 1503 (N.D. Ind. 2007).

If you need to surrender your home in bankruptcy, discuss your options with your attorney. In many cases it is beneficial to remain in actual possession of the home until the lender forecloses.