Short-Sales in Bankruptcy Cases
As the number of individuals tied to mortgages greater than the value of their homes rises, so does the appeal of short-sales, a process by which the borrower petitions the mortgage lender to accept less than what they are owed and allow a sale to clear title. Banks respond in one of three ways to this proposal. They can flat-out refuse: “accept $150,000 when you owe us $175,000 – no thank you!”). They can accept: “alright, I guess $150,000 is better than having to go through the cost of foreclosing and keeping another property on our books.” Or, they can accept with strings attached: “alright, we’ll let the sale go through, but we want you, the borrower, to pay us the $25,000 difference.” This process is often packaged as a cleaner, more sophisticated, cure to a problem traditionally remedied only by a foreclosure. Where foreclosures leave behind a scarlet letter, though, branding a homeowner as yet another victim of The Great Recession or, worse, part of the problem, short-sales seem to achieve the same necessary end (getting rid of a home with no equity) with none of the shame. Short-sales may make sense if a bank is willing to accept less than what is owed on the loan and agrees to waive the deficiency (the second response from above). But even in that ideal situation, the IRS will consider the bank’s kindness to the homeowner (waiving the $25,000 deficiency balance) as taxable income that must be accounted for next April 15. And, unless a family’s mortgage crisis is the only debt crisis occurring in the family, there may be so much additional debt accumulated while punching above their weight against their monthly mortgage payment that the escape hatch offered by the short-sale simply lands them in a pile of credit card bills that carry scarlet letters of their own. Bankruptcy is a scarlet letter of its own, of course, and a big one at that. But, in addition to forcing banks to waive whatever deficiency is generated by a foreclosure sale, it grants what no short-sale can: tax-free debt forgiveness and a comprehensive solution to debt problems that extends beyond the immediate difficulty of making a too-high mortgage payment. Clearly, bankruptcy doesn’t make sense for everyone, but in those cases where it does, bankruptcy and short-sales should usually be seen as mutually exclusive tools to achieve the same end: escape from real estate that no longer makes financial sense to keep, yet, for whatever reason, cannot be sold for the amount that is owed to the bank. The parties involved in a short-sale and those involved in a bankruptcy case often act at cross-purposes. In a short-sale, the seller, buyer, bank, and real estate agents all shift into “fire-sale” gear, where every day, if not hour, becomes crucial to the consummation of the sale. When a bankruptcy case is filed, however, everything slows. The debtor’s assets are no longer entirely his, and every sale or transfer of property, large or small, must be monitored closely by the Bankruptcy judge and trustee during the three month pendency of a chapter 7 bankruptcy case. This often puts the debtor in the awkward position of trying to accommodate impatient buyers and real estate agents while conforming to the requirements of the bankruptcy court. Such an imposition on the debtor (and his attorney) is not, in itself, cause to avoid commencing a short-sale during a chapter 7 case. But when such impositions are imposed with little or no benefit to the debtor, except the illusive promise of a more favorable credit score, one wonders whether they are really worth the effort. The good news is that chapter 7 cases are over quickly and their filing can usually be postponed to accommodate the sale of assets. Where there is a great deal of oversight of assets during a chapter 7 case, a debtor is perfectly free to transfer assets prior to their case as long as they receive fair value. If a short-sale is appealing, if the thought of a foreclosure smudging your credit score is unbearable, simply postpone the bankruptcy until after the sale of the property, or postpone the sale until after the bankruptcy. But avoid doing both simultaneously.