What happens to a subject-to loan if the seller files chapter 7 while it is still in her name?

Question

Here is a scenario worth walking through before funding any subject-to operator. Say the operator holds title on three houses where the underlying loans are all in the original sellers' names. On one of them the seller has said outright that she is carrying about 40k in unsecured debt and is talking to someone about bankruptcy. So: the deed is recorded in the operator's entity, the mortgage is still hers, she gets paid nothing further and has no ongoing interest in the property. If she files chapter 7, the trustee pulls her credit and sees a mortgage on a house she does not own. Does the automatic stay freeze anything about that loan, and can a trustee reach the transfer itself if she took, say, 9k for equity on a house that had more than that in it and she was already insolvent at the time? A private lender in this position would sit behind that first at 3.6%. It is worth knowing what the worst version looks like before anyone gets comfortable.

Rena Expert · Accepted Answer

The lien survives the bankruptcy regardless. A chapter 7 discharge wipes the seller's personal obligation on the note, it doesn't remove the mortgage from the property, so the loan and the payment stream stay intact and whoever owns the house still has to pay it or lose it to foreclosure. That part is the stable part.

The automatic stay is where the mechanics get awkward. Once she files, servicer communication with her is constrained, statements and escrow analyses can stop arriving in the usual form, and a servicer that learns the property was transferred out has a clean prompt to look at the file. Any actual analysis of stay scope, and of whether a trustee can unwind the transfer, has to come from bankruptcy counsel in her district, because the answer turns on facts about her solvency and the consideration she received rather than on how the deal was papered.

The exposure you're describing has a name in the code, and the general shape is that a transfer for less than reasonably equivalent value made while the debtor was insolvent can be attacked, with the look-back period depending on whether the trustee uses federal avoidance powers or state fraudulent transfer law, which runs longer in many states. A 9k payment against meaningful equity is exactly the fact pattern a trustee would look at twice. Whether it holds up is a legal question, and it's the one that decides whether your collateral is where you think it is.

The piece you haven't raised: her cooperation is worth more than her solvency. Escrow refund checks get mailed to the borrower, the loan's online access is hers, insurance correspondence goes to her, and a seller in the middle of a bankruptcy has no reason to forward any of it. A limited authorization on file with the servicer, obtained at closing, is worth more here than anything you can put in a note. Ask the operator whether he has one on this file, in writing, before you fund.

What happens to a subject-to loan if the seller files chapter 7 while it is still in her name?

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