Is BK A bad Thing For A Note?
First, a “BK” is short for bankruptcy. When a homeowner has gotten to the point of having to file for bankruptcy, things are pretty serious. There are a few different types of bankruptcies for consumers, the most typical are Chapter 7 and Chapter 13. Most businesses use Chapter 11, and some consumers can as well if they have a really high net worth.
Let’s stick with the most common, CH7 and CH13 for the basics. Bankruptcy is essentially a plan to repay your creditors and reorganize your debt. Perhaps you have gone through a divorce, have medical bills that are too high to pay, maybe just irresponsible with money and find that you need a restart or even protect a real estate asset.
A borrower that files a CH7 is likely going to discharge all of their debt. Basically, this means that all their debt is wiped out and the creditors get nothing. The consequence of this action is that the blemish will stay on your credit report for 10 years. This can affect many other things other than the ability for you to get future credit. CH7 will mean that you may be able to get more credit right away, but the interest you will pay on that credit will be astronomical. It may affect some employment for certain positions. It can affect insurance rates, renting an apartment, etc. Also, not everyone is eligible to discharge their debt in CH7. You must prove that you have no available income to pay any of your debts.
In the even that you do have a job making some income, most courts will force you into a CH13 repayment plan. A court trustee will be responsible to distribute funds to your creditors based on the amount you have left after your secured major bills such as mortgage, car or child support. Most people who are in a CH13 have a home that they may be trying to hold on to, but their credit card debt or other debts make it impossible to do. If you have a job, but you can’t afford to pay for your home even after filing BK, then the court may force you to sell the house.
There are consequences to CH13 as well, it stays on your credit report for 7 years. While you are in the CH13 plan, you are not allowed to apply for any credit without first getting approval from the trustee to do so. For instance, if your car broke down and you needed to get a new one, you may get approval to incur new debt for a new car.
As this applies to note investing, many note investors love to buy notes that are in BK because they are more apt to get payments since they are coming from the court trustee. This is only good if the borrower completes the BK plan though. If the plan is dismissed for non-payment, then the note investor must go through the foreclosure process.
So, while BK may not be the best thing to do, it may save the borrower to be able to stay in their home and ultimately get back on good financial footing.