Tuesday, July 31, 2007

Is a Short Sale Better Than Filing Bankruptcy?

Question: The payments on my adjustable rate mortgage are going through the roof. I owe more than my property is worth, so I cannot refinance to a fixed rate mortgage and I just can't afford my payments any more. My real estate agent tells me that a short sale is better than letting the property go in a foreclosure or a bankruptcy. What should I do?

I've seen real estate agents try to push short sales as a cure all to avoid bankruptcy. Quite frankly, the answer just isn't that simple. A short sale should only be considered after weighing all of your options, including bankruptcy and foreclosure.

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. Before allowing a short sale a lender will want to see how such a deal can be structured. Perhaps the borrower has other assets, or perhaps the short-fall can be made up with a note to the lender.

If the lender forgives a portion of the debt, debt forgiveness over $600 must be reported to the IRS as income to the borrower -- money not actually received by the borrower, but money that is taxable. On the other hand, debt forgiveness received in bankruptcy is not taxable.

A successful short sale gives the 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.

One factor that real estate agents often do not consider 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. Preventing a short sale won't do much good to protect a consumer's credit rating if a bankruptcy becomes necessary at a later date.

Every situation is different, but I see many clients who who cannot afford their mortgage payments and they usually have other debt problems. Sometimes paralyzed with fear, the do not know which way to turn. In many cases, their best option is to file for Chapter 7 to get out from under all of their debt problems and avoid the potential tax problems with a short sale and 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 and a tax professional. Short sales are not a magic solution that some proponents make them out to be and you must look at your global decision before deciding which course of action to take.

About the Author: Carl H. Starrett II has been a licensed attorney since 1993 and is a member in good standing with the California State Bar and the San Diego County Bar Association. Mr. Starrett practices in the areas of bankruptcy, business litigation, construction, corporate planning and debt collection.


Emmer said...

Due to a recent business failing I am forced to declare a chapter 7 bk. As such, I am also considering walking away from my home or conducting a short sale. My thinking is I'm already going bankrupt and my credit will be ruined for years, why not take care of all my problems at once? Will the add'l foreclose/shortsale on my record cause me add'l credit problems in the future or am I "already wet, so I might as well jump in"??

Interested in your comments. Thanks!

Anonymous said...

i am going thru a divorce and my wife & i are both on the mortgage which hasnt been paid since may 08 its now feb 09 part of settlement was to sell the hse in a short sale.there is a perspective buyer but i want to know if i sign the contract with the buyers to present to the bank can i then file chap.7 while thats in process?

Carl Starrett said...

Emmer: I generally prefer to have a bankruptcy on file before a foreclosure to minimize any potential tax consequences. A short sale won't take care of your other debt problems.

Anonymous: A bankrutpcy will temporarily halt the short sale due to the automatic stay. It is hard to predict what the ultimate outcome would be in terms of the sale going through or not.

Susan said...

It's quite interesting to understand the different options or alternatives available to those in a foreclosure/short sale situation.

Anonymous said...

I am selling my home through short sale but i have decided that a bk 7 is better for me to eliminate all debt at once... my real estate agent refuses to cancel the listing and is threatning to file a lawsuit for breach of contract, etc... she has a possible buyer that wants to open escrow. They have no idea I am filing a Bk7, can I do this and then stop all the harrasing calls???

Carl Starrett said...

It sounds like the real estate agent is blowing smoke. I would contact a local bankruptcy attorney about your options and consider reporting your agent for a possible ethics violations.

Anonymous said...

Thank you!! I have been searching for answers regarding short sale vs. bankruptcy.

I searched other sites that explained the options, but not whether either one was a better option.

I am behind on my mortgage and have many other bills due because I've been trying to catch up, which seems impossible. I'll be filing for Chapter 7 today, more knowledgeable about the decision I made. Thanks.

yg in AZ

Anonymous said...

I am currently considering short-selling my home, but I am afraid that even after the short-sell, the lender/bank will continue to pursue me for the difference. Is that possible? How long does it take generally to obtain the lender's decision on whether to accept a short-sell? I do not want to file for bankruptcy considering that I do not have any other overdue outstanding debt, it's just the house that is seriously weighing me down, otherwise, I have extremely good credit standing. In this context, would short-sell or bankruptcy be a better option for me?

Anonymous said...

I have a situation where I was considering a short sale, with me being about 165K upside down on my house. I also have about 35K in credit card debt due to me being unemployed all last year. The BK attorney i met with for a free consult tells me, that since I just started working, they would take my income for the past 6 months, to determine my payback period, allowing me to do mine in 36 months versus 60. My question is, since my second is a heloc, and she wants to strip away the lean, is it better to do a 13 over a 7? She leans more toward a 13, as she said the second will go away. The only concern is as my income increases, so do the payments on a 13 as they are evaluated each year?? thanks

Michel said...

I would contact a local bankruptcy attorney consider reporting your agent for a possible ethics violation. I always believe in following in ethics for any type business to succeed.

Anonymous said...

As recently as 8 months ago I was able to conduct a short sale on my home in Kissimmee, FL. The only way Fifth Third Bank agreed on the price was if I agreed to repay them 40K over the next 30 yrs which I agreed due to desperation. Doesn't the bank have some type of insurance so that they don't loose out? Is there any way I can free myself from this debt?

Anonymous said...

Short sale is better for you can rebuild and buy again in a shorter time. If you file bankruptcy, short sale is still better. Its not about if i am in the hole already, because you are. its about how deep you want to be in the hole and how much harder will it be to get out?

Anonymous said...

In 2000, I did a short on my home. I filed bankruptcy prior to the sale so that the 2nd position loan would not come after me. The short sale was as disastrous on my credit as a foreclosure. Just sayin' if I had to do it all over again I would walk away from the house.

In my current home I am upside down. I've had it on the market for 6 mos and no bites. I've applied several times to the Making Homes Affordable Program but it has been impossible to qualify for one reason or another. America's Servicing Co. (aka Wells Fargo) is like dealing with a huge snake---only a snake is smarter and has more compassion.

I've lost everything else but I keep making the payments and have never missed one. My health is suffering (diabetes and leukemia) and I'm 62 years old and single. I'm working just to pay Wells Fargo and when it eventually kills me, I guess you good people out there will stop judging me and calling me a scum bucket for wanting to file to do a stragetic defaulty and file bankruptcy.

Mark said...

I'm involved in a short sale. Last October 21 the seller filed for Chapter 7. One of his creditors, Amex has a lien on the house. BofA and Equator have approved our counteroffer and just gave a closing date of March 15. The realtor says that the lien will be removed by the trustee before the bankruptcy goes through. I see no evidence of this. In addition, if no protest is filed by next Friday the 20th the clerk of the US Court said the bankruptcy would go through in 5 business days from then. What happens to the short sale if he is already bankrupt before we close?

Anonymous said...

I am single, on disability. I live off assets which were substantial to last a lifetime until 2008. I have enough money to last me 4 years. I have an annuity that does not kick in until 2019 and will double if I do not touch it until then. Meanwhile I would be short 7 years. I cannot afford to pay for the house I am in- too big and a drain on my assets. I do not have a job- I am on disability.
My house is for sale but it is on the lake, very expensive and I need to sell. But since I do not have a job and banks have tightened requirements, I do not have the money to buy another house if i do not get equity out of present home. But if I stay in house another year I will pay in mortgage adjustable interet payments what I would have deducted from my only assets.

Target is to find apt or house affordable on disability and only $500-$1000 a year from assets.

What is best. Home in area just sold for $400,000 less than it is worth. I am afraid if my home goes that route, I will com eout with nothing and eating away my assets to live here.

Thought about walking away- forecloser, bankrupcty but I am 58 and on disability and cannot work.

Life is cruel- the banks contributed to my problem but that is history and the bank is being investigated now too- JP Morgan.

The original loan for an addition was with a bank (Home Bank) that went belly up. So I was cuaght in finishing disability addition with my equity line. And the loan is still an ARM because they changed the rules. I bought the home when I had no job but had assets stocks and bonds. I added an addition and when I wnet to close on that part to roll everything over to a jumbo loan, I did not qualify for the home I live in????? So I have an ARM and an equity line and paying through the nose on interest.
Laon is 6% and equity line is 2.7 but I cannot manage this with eceomny dwindling my assets.
Like I said. I have about 4 years of money left then a lag for 7 years before I can touch the annuity.

In limbo and sinking but can see the problem but cannot get out of it in time I fear.

Its a mess.