Does it Make Sense to Give Up Your House in Bankruptcy?

If you're struggling with a mortgage that is too much to bear, or if you're already delinquent, then you may be considering letting it go. If you're also up to your eyeballs in debt and considering bankruptcy, then it may be a good idea to get it all done at once, and start over with a clean slate.

Before you decide which route is best, you'll want to know what options are available, and which approach may be best for your particular situation.

First. Secured vs. Unsecured Debts in Bankruptcy
Most consumer debts are unsecured, and include credit card debt, personal loans, payday loans, debt from medical bills, etc. They are not "secured" by any collateral. In a bankruptcy, these debts can usually be wiped out, leaving you free from any liability to repay them.

Your mortgage, on the other hand, is a secured debt. Like any other secured debt it has two parts; the debt and a lien on collateral. In this case, the collateral is your house. In a bankruptcy, the debt can be discharged, but the lien remains. This means that if you choose to discharge the mortgage debt, you'll lose the house because, while you're not legally liable to repay the debt, the lender has a legal right to the collateral.

Why You Might Want to Walk Away
As painful as it is, it can often be financially advantageous to let your house go in a bankruptcy. This is usually the case when the value of the property has become less than the loan you're paying on to own it. After all, it's doesn't make sense to be in a $500,000 hole for property that's only worth $250,000.

More pragmatically though, sometimes adjustments in interest rates make keeping up on the mortgage impossible. Even if you really want to keep the house despite it's lower value, you simply may not be able to afford it. Sometimes walking away isn't a choice, it's the only option other than letting the bank foreclose. See this post on your options when facing foreclosure for more on that.

Outside of a bankruptcy, you would probably be held liable to pay the difference between your mortgage amount and the sale price of your house if you chose to walk away. In a bankruptcy though, this "deficiency" is discharged along with the rest of your debt, which is why people often consider bankruptcy when mortgage debt becomes a problem and they decide to walk away from the house.

Choosing to Keep the House
If you're in a situation where you have positive equity in the property and a stable income, but other debts are keeping you from being able to save and grow your worth, then you can choose to reaffirm the mortgage debt and keep making your payments. It would be as if the house was kept "out of the bankruptcy", so to speak. This allows many homeowners to be able to maintain their mortgage simply by freeing up a lot of income that otherwise went to debt payments.

The Bottom Line
The reality is that in a bankruptcy, much like any other financial decision, the option that ensures the best outcome for you financially is the one to choose. If you can save your home from a possible foreclosure, you have some equity in it, and you can afford the mortgage, then by all means make that choice. Just be sure that your decision is based on sound financial motives, and not an emotional attachment to a house (and the associated debt liability) that is going to keep pulling you down and preventing your financial growth.

Want to Learn More? Check out the following resources for more information:

1. Nolo has published the entire book on foreclosure for free online.
2. Our Guide to Bankruptcy Law