Is Owner Financing an Alternative to Foreclosure?

26 Feb Is Owner Financing an Alternative to Foreclosure?

I had an interesting question today from a client who is preparing to file bankruptcy. When he and his wife married, they each owned a home. They moved into one, and rented out the other.

They have been talking with their tenant for some time about buying the home, but she has so far been unable to obtain financing. They asked whether they could owner-finance the tenant’s purchase of the home, and whether that would affect their bankruptcy. If they are unable to keep the property rented, or sell it (extremely unlikely in the current market) they will have to surrender it to foreclosure.

There are a couple of issues raised by the prospect of owner-financing, also referred to commonly as a “contract for deed” arrangement. First, it should be noted that if you sell under such an arrangement, the contract, or right to receive payments, is an asset, and must be disclosed.

The payments you receive will also count toward the means test analysis, but since that is technically “business income” any expenses paid–mortgage payments, taxes, insurance, upkeep–will be netted out of that income. The income, and the expenses, will also show up on your budget, and because that is a kind of business, some courts or trustees may require a separate “business budget.” Those are fairly minor concerns, however.

To me, the larger concern has to do with what happens if things go badly between my client and his purchaser. South Carolina (and probably most other states) treats a contract for deed like a mortgage, because the purchaser is more than a renter, and has some ownership of the property. Therefore, if the purchaser fails to make the payments somewhere down the road, my client will have to sue for foreclosure. That takes time, and can be expensive.

If the seller is relying on the contract payments to pay the existing mortgage, there may be a period of time when he’s not getting payments from the purchaser, but the mortgage company is still looking to him to make the payments. Although the bankruptcy will discharge any personal liability for the mortgage, there is another issue.

One of the keys to rebuilding a positive credit rating after bankruptcy is to ensure that payments coming due after bankruptcy are made on time. The contract for deed has the potential to create a post-petition default, which can make rebuilding credit that much harder.

Of course, that is just one factor to consider in deciding whether owner financing is a good alternative to letting the property be foreclosed. There is the potential for profit to be considered, and the credit-worthiness of the buyer. But, if the likelihood is that the property is going to end up in foreclosure in any event, it may be better for purposes of your credit rating to let all the bad stuff happen at one time.

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Däna (pronounced "Donna") Wilkinson, has been a bankruptcy lawyer in South Carolina for 20 years. She is certified as a bankruptcy specialist by the South Carolina Supreme Court.
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