investment property

I’ve decided to file for bankruptcy, do I need to go through with my short sale?

The benefit of continuing with a short sale after you’ve decided to file for bankruptcy will hinge on the type of bankruptcy you plan on filing.

If you have decided to file for chapter 7 bankruptcy and are currently trying to sell a home via short sale, there is usually no reason to continue with the short sale. The purpose of a short sale is to relieve the borrower’s obligation to pay the difference between the sale price of the home and the mortgage amount when the property is “underwater”or worth less than what is owed. Bankruptcy gives the borrower the option of surrendering the property back to the bank with no continuing obligation under the mortgage and no corresponding tax liability for the forgiveness of debt (usually a taxable event).  In essence, surrendering a home in bankruptcy allows the borrower to simply give back the keys and walk away, leaving the purpose behind the short sale moot. Bottom line: if you are going to file chapter 7 bankruptcy, why deal with the stress of negotiating a short sale?

However, if you still live in an area where homes are severely underwater and there is a backlog of foreclosures, it could make sense to go through with a short sale to get title out of your name. When a home is surrendered via bankruptcy, the bank still must foreclose to remove the owner’s obligation for HOA dues etc…

Chapter 13 bankruptcy

The analysis is slightly different in a chapter 13 setting. Chapter 13 bankruptcy allows the debtor to surrender a home as well, however, any remaining deficiency judgment after foreclosure will be paid out as unsecured debt through the chapter 13 plan. Huh?

Even though the property is being surrendered, the bank is still obligated to foreclose to clear title. The foreclosure process will result in a sale of the property. If the sale price is less than what is owed on the mortgage, a deficiency judgment results. Subject to state law, outside of bankruptcy the borrower would be personally liable for the entire amount of the judgment. Generally, a chapter 7 bankruptcy will eliminate all unsecured debt including deficiencies after a foreclosure.

By contrast, in a chapter 13 bankruptcy, the deficiency between the foreclosure sale price and mortgage amount will be paid out as unsecured debt, at far less than 100%. Because the debtor will still be responsible to pay some of their unsecured debt through the plan, a short sale that slashes this debt before bankruptcy remains beneficial. Therefore, if a borrower can negotiate a short sale prior to filing for chapter 13 bankruptcy, she will reduce her plan payment by reducing her unsecured debt. Bottom line: completing a short sale before a chapter 13 bankruptcy has the potential to lower your plan payments.

It is always wise to consult with an experienced bankruptcy attorney if you have questions.

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  1. […] payments unaffordable, banks refuse to modify mortgages after months of “review” and a short sale is far from certain (again requiring lender approval). Even a foreclosure doesn’t provide […]

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