Bankruptcy Short Sale

13 Replies

What do you say to a seller when they ask how does a short sale benefit me after I've done bankruptcy? Are there even any benefits? What I've been saying mainly is that its added protection and gets your name out of it, but it doesn't work on every seller.

The added benefit? Hmm...cash for keys is the only thing I can think of but i'm not sure i'd call that an added benefit per se.

Not sure how a short sale is, "added protection". Added protection from what? and "gets your name out of it"? What's that mean? They alraedy have no contratual liability even though their name is on "it". They have no other liability assuming they have insurance, which they are required to have, and the lender will force place if they don't have so, I don't see any benefit there.

Each situation is different so, your approach will be different. If they've already vacated the home, there are not a lot of incentives that I can see. if they are still in the home, cash to move may be an incentive. Maybe they want a mod instead?

Originally posted by @Hasan Hamdan :

What do you say to a seller when they ask how does a short sale benefit me after I've done bankruptcy? Are there even any benefits? What I've been saying mainly is that its added protection and gets your name out of it, but it doesn't work on every seller.

By "done bankruptcy" mean that it was discharged?

If he's not making his payments, a foreclosure has a whole new bag of negative credit implications that are separate from a BK.  It could take the seller twice as long before he/she can buy another home.

I'm missing something here.  If the seller can't make payments and is eligible for a short sale, why wasn't this dealt with during the BK?  Coming out of bankruptcy with payments you can't make defeats the purpose.

I am a bankruptcy attorney. Most of this discussion is for chapter 7s. Chapter 13 is more complex as it is generally filed to save the home. The issues in a 13 post discharge are probably not too difficult but a 13 lasts from 3-5 years. Assume I am talking about a 7 going forward. They are more common.

Bankruptcy takes away the debtor's in personam liability (legal term for liability against the person). It does not deal with the In rem (liability against the property) rights of the debtor.

Debtors can leave a bankruptcy under chapter 7 still in the house and current on their payments. They do not personally owe money on the house but it is legally their house and the lien of the mortgage holder is still valid. They have to continue paying under the terms of the note or surrender the property. This can happen any time before the loan is paid off.

The mortgage holder's only remedy is to foreclose for non payment if the debt was not reaffirmed. If it was reaffirmed, the debtor is personally liable for the debt again. There is no judgment against the debtor for personal liability after a bankruptcy discharge of the debt.

So, to your original question, what are the benefits?

1. PP stated it. No foreclosure on their credit report.

2. If they reaffirmed, they will not get personally sued.

3.  An additional issue is what are called "zombie mortgages". When the value of a property becomes a negative, some lenders will not foreclose. Nothing requires them to do so. You can have a situation where a debtor has filed bankruptcy, abandoned a home and get a tax bill or nuisance notice three or four years later.  They assumed the bank would take care of the house and the bank did not. The Debtor is still the legal owner of the property. They could be potentially liable for the debts arising post filing and not even know it.

The reality is there is little incentive for the bank to do a short sale after bankruptcy. The reason is all of the legal issues someone in bankruptcy is dealing with. The bank is taking a chance that the title will be clean in the short sale process. There is little question in a foreclosure. The bank should get good title. They have already lost the right to go after the debtor and have already spent money on legal fees.

I would love to hear of individuals who have done this successfully. There is a lot of public info in a bankruptcy filing that would allow you to target potential leads. However, I don't see the motivation for the banks. 

@William Hochstedler

 @Ron S.

Thank you all - let me clarify. Yes I do mean a discharged bk. Also I am in New Jersey if that makes a difference law-wise Paul. William, the sellers are not making payments. As Paul said they did bk but house stays in their name, so they don't owe money on the mortgage but they are tied to the house until it is foreclosed. In addition, laws continue changing so doing a short sale cuts those ties to the house, but 7,8,9 years later by doing nothing a foreclosure can pop up and who knows what the banks will do at that point. 

I have completed short sales after clients have done bk. I actually deal more with people who have done bk than people who haven't. The question here was how can it benefit them, because it clearly doesn't hurt them. They have no financial liability, they don't pay me, but I want an extra short sale in my pipeline. Since they have no reason to care, how can I keep them motivated throughout the process, its more for me than for them, but the reason I asked is if there are any benefits I am unaware of, I can start telling my sellers. Some clearly state they are doing it to help me out because they know it doesn't really affect them.

In another forum the best answer I got was in regards to whether or not they plan to purchase a house in the next few years or future, in that case, a short sale is a much better bet.

Originally posted by @Hasan Hamdan :

@William Hochstedler

In another forum the best answer I got was in regards to whether or not they plan to purchase a house in the next few years or future, in that case, a short sale is a much better bet.

You also got that answer here.  A chapter 7 gives the debtor a clean slate.  By not addressing the missed mortgage payments, they will be unable to start improving their credit and build a new life for themselves.  The ongoing credit dings will make it hard for them to borrow on anything until it's resolved.

The length of time before lenders will lend to borrowers with a foreclosure is much longer than a with a BK only.  If they hope to buy a house again in the next 5 years, waiting around until the bank forecloses will almost certainly prevent that.   

The problem with doing a short sale (or waiting until foreclosure) after a BK is that they may still be liable for a deficiency judgement, but I'm not certain on this.  @Paul Choate ?

@William Hochstedler There's no issue of a potential deficiency after a BK with either a short sale or a foreclosure, as the underlying debt has been eliminated. However, I've never done a short sale without forgiveness of the remaining debt.  Also, many will do the BK prior to a foreclosure or short sale because the elimination of the debt through BK also eliminates possible taxation on any "forgiven debt", because the debt was already extinguished in the BK.  One other development last year, if they seek conventional financing later (4 year minimum from BK), a later foreclosure on the same property doesNot reset the waiting period, as it used to.  My understanding is that a short sale Does reset the clock.

@ Paul, with all due respect, I disagree with you on a couple of issues. There is no increased liability for a lender to do a short sale post BK. There is no potential increase in a possible title issue either. Just like a normal open market sale, there is a seller and a buyer and both open title and escrow and both pay for policies to ensure clear and marketable title. It doesn't matter if it's a short sale or an open market sale. It still processess the exact same way, closes the exact same way and funds the exact same way. The ONLY difference is the funds disbursements to lien holder(s) may be short of full pay off.

Also, there is no foreclosure on a credit report post BK, if the lender forecloses. As a BK attorney, you must be well aware that once there is a discharge, there is no subsequent derogatory reporting on the borrower's tradeline (Assuming the foreclosure happens AFTER the BK discharge).

@William - There is no deficiency judgment possible post BK, unless they reaffirmed the debt. In some states (Like California), it wouldn't matter if they reaffirmed or not, deficiencies are not allowed by statute.

@Wayne Brooks

a later foreclosure on the same property doesNot reset the waiting period, as it used to. My understanding is that a short sale Does reset the clock.

Do I understand you correctly that a foreclosure is actually better for the debtor than a short sale regarding future time lines?

@Ron S.

In some states (Like California), it wouldn't matter if they reaffirmed or not, deficiencies are not allowed by statute.

This is true regardless of bankruptcy for primary residences, correct?

@Hasan Hamdan

 Bankruptcy law is federal law and is substantially similar across the U.S. There are always nuances between the different districts and even between judges but that doesn't really matter in this discussion because the variations are in the various foreclosure laws of the states. That could change the benefits and costs for the debtor. As stated before, these are just the general guidelines for pitching to debtors the pros of working with you.

I think @Wayne Brooks  brought up two very interesting points: tax liability for forgiven debt and the waiting period restart. Tax liability- Debtors are not responsible for forgiven debt after the bankruptcy as Wayne said. IRS form 982 is used after the filing of a bankruptcy if a creditor sends a 1099 for forgiven debt. Some accountants or tax preparers are not aware of it. Wayne, that is very interesting on the waiting period restart and could matter to the debtor.

@William Hochstedler  deficiencies after a discharge are not an issue as Wayne said. However, I have seen deficiencies arise outside of bankruptcy but that is more of a deed-in-lieu situation.

@Ron S. bankruptcy does not always remove all liens (i.e. judicial liens, mechanics liens, tax liens etc.). Once a lien is attached to the property, it has a legal existence of its own pursuant to state laws. When the mortgage holder is in first position they do not care as they can clear all of this off through the foreclosure process. You as a short sale buyer have to know what you are buying, just like when you buy at foreclosure auctions. Except in a short sale, there is no judicial mechanism clearing off all of the junior liens. So it is great there are banks out there willing to go through all of the work to do this in a short sale. Many debtors have no extra liens. It does not mean there is no risk or extra work. I assume it must be a state by state thing. In my area the banks just don't mess with it much.

You are incorrect about the reporting of foreclosure actions on a credit report. Foreclosures are public records they do not come from the creditor and therefore do not violate the automatic stay. Public records are facts not collection attempts.

@William Hochstedler

 Only in that very specific situation, where the debtor will be trying to use conventional financing in 4 years. Of course, they may change in 4 years from now.  It was changed due to the constant problem that after doing a Chapter 7 BK, the debtor has no control over when the bank forecloses, and it could be 4-5 years later.  I have one now, no active foreclosure, 8 years after BK.

Originally posted by @Wayne Brooks :

@William Hochstedler

 Only in that very specific situation, where the debtor will be trying to use conventional financing in 4 years. Of course, they may change in 4 years from now.  It was changed due to the constant problem that after doing a Chapter 7 BK, the debtor has no control over when the bank forecloses, and it could be 4-5 years later.  I have one now, no active foreclosure, 8 years after BK.

 Out of curiosity, on the one you're working on, has the borrower been able to secure a loan for a new home in this situation with an open default?

@William Hochstedler

Yep, they got it done, not sure on the exact financing, as they are in GA now. They were having conventional financing issues simply because the house was in their name, and at the time, 2 months ago, there was an active HOA foreclosure.

@Paul - I never said a word about BK removing liens in my post but while on the subject when they do, it's only upon completion of a 13 where the debtor filed and was granted a lien strip. You said short sales aren't popular post BK because of increased legal issues. I said your wrong because there aren't any increased legal issues.

To your second point: When the debt is dicharged in Bankruptcy, and the lender codes the account in Metro II format to the bureaus, as debt included in Bankruptcy, THAT trade line will not show as a foreclosure. It will show a zero balance, with a BK designation. Whether there is a foreclosure in the public records section of a credit report or not, is another story. Re read my original post...I said ON THAT TRADELINE, not that it would not appear on the public records section.

We may be splitting hairs here but, i felt a further comment was warranted.

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