The bankrupt's house

Contributed by Ian Macdonald and current to 1 September 2005

TENANCY

If persons considering bankruptcy are tenants, bankruptcy is not a problem unless they owe the landlord money. Bankruptcy may help people keep their rented home. If bankruptcy frees them from other debts, they can concentrate on paying the rent, and thus have secure housing.

Bankruptcy can create a problem for persons who want to enter a new tenancy, because they should disclose their bankruptcy status before going into a lease where the total liability under the lease exceeds $4,067. Homeswest, like any other landlord, cannot evict tenants because they are bankrupt. However, all landlords (including Homeswest) can evict a tenant for non-payment of rent, and can refuse to house a person in the future due to a bad record as a tenant in the past.

OWNING A HOUSE

Perhaps the biggest factor putting debtors off bankruptcy is house ownership. In Australian law a family home is not protected property, so it passes into the ownership of the trustee in bankruptcy. What happens to a house when the owner becomes bankrupt depends on how much equity the person has in the house. Equity is the difference between what the house is worth, and how much is owing on it.

If the equity is small, the owner may be able to get a family member or friend who is not in financial difficulty to buy the equity from the bankrupt estate. This means the bankrupt can continue to live in the house, but still have the advantages of bankruptcy.

NEGATIVE EQUITY

If the amount owing on the house is the same as the value of the house there is no equity. If the amount owing on the house is more than its value, there is a negative equity. If a person in this situation becomes bankrupt, this equity still becomes a part of the bankrupt estate. The bankruptcy administration may put a caveat on the title to show their interest. This means a document is lodged at the Titles Office that affects that property, and restricts the way the title can be dealt with.

A bankrupt in this situation should do something to deal with this equity, because the bankruptcy administration has up to six years after discharge in which to assert a claim to the house if it has been disclosed. A trustee has up to twenty years to assert a claim to property which the bankrupt has not disclosed. Even though the equity may not be worth anything, or it may be worth less than nothing, the bankrupt may still be wise to have a friend or family member offer the trustee a nominal sum, such as $1,500, in order to keep the house.

If there is a large negative equity, for example if a house is worth $70,000 but a total of $110,000 is owing on it, the bankrupt may be better to leave the house, so that the debt on it disappears into the bankruptcy along with other debts. The lender can take the house back and sell it and keep the money it sells for. However, the lender cannot do anything to the bankrupt for the money it has lost.

In each case a person who owns a house and is considering bankruptcy should work thoroughly through the figures, and see what the best option is. It is important to take into account the full amount secured on the house. For example, a finance company may have taken a second mortgage on a house to secure a loan to buy goods. There may also be unpaid local government and water rates. A house with a Defence Service Mortgage has a special status in bankruptcy and debt collection law. Section 45A of the Defence Service Homes Act 1918 (Cth) prevents a trustee in bankruptcy or a creditor selling the house unless the owner has created some other security on it, such as a second mortgage to a finance company.