July 1, 2010

Short Sale Vs Bankruptcy

Posted in Bankruptcy, Short Sale tagged , at 1:40 pm by demetriagraves

I’ve had many of my clients come to me wanting information on short sales and bankruptcy. In particular, I’ve been asked by clients who are considering filing for bankruptcy if they should proceed with a short sale on their real estate.  This is a very interesting question and becoming more common these days. Most people don’t fully understand what a short sale is and how that may affect a possible bankruptcy filing.

If someone is upside down on their mortgage either a short sale or filing for bankruptcy could be an option but often people come to me wanting to do both. In my experience, it seems that a short sale or filling for bankruptcy are different alternatives to solve the same problem. So how do you know which one is best for your own individual circumstances? Obviously getting some advice from an experienced family law attorney is vital as a first step. The purpose of the article is to go over some of the basics on short sales and bankruptcy to help clear up any possible confusion on the subject.

A short sale is where the the lender takes less money than is actually owed because it may be a better alternative for the lender than a foreclosure sale in a down market. You are asking the lender to approve the sale without receiving the full amount of their loan, which is very common now in this depressed real estate market. For example: you bought a home in 2005 for $500,000 with a first mortgage of $400,000 and second mortgage of $100,000. The property is now worth $300,000 and you have a buyer willing to pay $300,000. If the first mortgage agrees with the sale, they will receive about $100,000 less than their current debt and the second will receive $0. Typically the second signs off with a nominal payment such as $5,000.00.

What many people don’t realize is that they could be liable for tax on the $100,000 debt that has been forgiven in the above example and the lender will issue you with a 1099 which needs to be declared to the IRS when you do your taxes. Most people qualify for exemptions to this and won’t end up having to pay tax, particularly if it’s their primary residence or if they were insolvent. But this ‘income’ still needs to be declared and the appropriate paperwork for any exemptions submitted to the IRS.

A successful short sale gives a homeowner some control over their destiny. The homeowner may be able to avoid bankruptcy and a foreclosure on their credit rating with a successful sale. However, short sales are often time consuming and difficult to negotiate and they can still adversely affect your credit.

One factor that’s often not considered is the total debt picture of the homeowner. While a short sale may resolve the issue of escalating mortgage payments, the homeowner may have other debts that need to be dealt with in a bankruptcy. A short sale won’t do much good to protect a consumer’s credit rating if a bankruptcy becomes necessary at a later date. Bankruptcy is an option for borrowers when doing short sales. One thing that lenders should be made aware of is that by accepting your short sale offer the lender will not have to deal with a possible bankruptcy by the borrower!

Depending on your circumstances, often there are very good reasons to file for bankruptcy. These would include things like avoiding financial liability for those credit cards you got in over your head with. Or maybe to avoid having to repay the balance on a underwater mortgage for a house that you plan on giving back to the bank. Perhaps you have some outstanding car loans on a car that has been repossessed or is about to be.

There also might be good reasons for doing a short sale. For example, it may save your credit from the hit of a bankruptcy for the home that’s under water. But both? If you have already made the decision of filing bankruptcy, who benefits from doing a short sale? When a borrower files for bankruptcy the lender cannot pursue collection of the debt and it stops the foreclosure process during the bankruptcy. When accepting a short sale the lender does not have to be concerned with the borrower filing bankruptcy and having to wait an indefinite amount of time for payment or to complete a foreclosure.

Plus when you file bankruptcy, there is no transferring or selling of your property. Without taking additional measures, basically you cannot sell your property while in bankruptcy. Why would you want to? You can let the bankruptcy take care of the upside down mortgage and any other debts that you can’t pay.

Every situation is different, but I when I see clients who who cannot afford their mortgage payments they usually have other debt problems. Sometimes paralyzed with fear, they do not know which way to turn. In many cases, their best option is to file for Chapter 7 bankruptcy to get out from under all of their debt burden and avoid the potential tax problems with a short sale or letting the bank take the property back in a foreclosure.

The only way to determine what is best for your situation is to seek the advice of a competent attorney who is experienced in this area. Short sales are not always the magic solution that some proponents make them out to be. It’s vital that you’re fully informed on all your options before deciding which course of action to take. I offer I free confidential initial consultation where you can get your questions answered and you can get the guidance that you’ll need to navigate your way through these difficult circumstances.
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