Short Sales and Bankruptcy
For many people, a short sale becomes necessary when they no longer are able to make their mortgage payments on a regular basis. A short sale occurs when the sale of the property results in less money than is owed on the mortgage(s) encumbering the property. While it is important enough for some people to be rid of the obligations of the mortgage to go through this process, a short sale will result in an impact on credit scores and other financial consequences. Further, there are situations where the homeowner still is obligated to make payments on the difference between the home sale price and the amount due on the mortgage, even though they no longer have the benefit of the property.
Depending on the mortgage lender, there are times when a lender only will agree to release the lien on the property for a short sale, thereby allowing the property to be sold, if the homeowner agrees to sign a new unsecured promissory note. Once the property has been sold, the former homeowner now is obligated to make payments on the new note. Even absent a new promissory note, the documentation necessary to effectuate the short sale may reinforce the homeowners’ responsibility for any deficiency between the sale price and the outstanding obligation, so it is critical to read the small print.
One of the main reasons that a lender will agree to a short sale is to avoid the financial costs of a foreclosure, which involves significant legal costs and fees above that of a short sale. Once the lender is satisfied that the homeowner really cannot afford the monthly payments any longer, it may be more economical for the lender to approve the short sale rather than force the mortgage into foreclosure.
The financial position of the buyers that necessitates the short sale usually means that there are other debts that burden the homeowners. For this reason, many people begin the process of a short sale while contemplating or pursuing bankruptcy. There are reasons why this may be more beneficial than a foreclosure during bankruptcy.
Bankruptcy Actions and Short Sales
There are a number of considerations when deciding whether or not to pursue a short sale as part of a bankruptcy case. Although it may not be right for everyone, the fact is that a person can go through a short sale having filed either a Chapter 7 or Chapter 13 bankruptcy. One of the reasons that this is permissible is that there is no financial benefit for creditors to object to a short sale since there is no equity in the home that can be claimed to satisfy outstanding debts. However, most short sales that happen while a person is pursuing relief through a bankruptcy case were started prior to the filing of the bankruptcy case.
If a homeowner is pursuing a short sale of his home during a bankruptcy action, there are a number of steps that must be taken in order to ensure a valid sale. Once the home is under contract, it is necessary to get the approval of the bankruptcy court before moving to close on the home. After the motion for approval has been filed with the court, there is a mandatory wait period of 14 days in order to be certain that there are no objections to the sale. Once this period has passed, the sale of the home may proceed through escrow to closing.
One of the big questions about a short sale in bankruptcy is whether or not this is the best option. During a bankruptcy case, it is possible to surrender the house to the lender for foreclosure. Some of the benefits of doing this include:
Zero balance due and owed on the mortgages if the house is surrendered to the bank; and
There is no “forgiveness” of the outstanding balance of the mortgage, which avoids negative tax consequences.
The tax consequences are a serious concern for homeowners right now.
Mortgage Forgiveness Debt Relief Act and Bankruptcy Actions
Right now, there are many homeowners who are contemplating filing for bankruptcy in order to take advantage of the fact debt is forgiven without tax consequences in bankruptcy rather than go through a short sale. Much of the uncertainty that exists in the market is because Congress has failed to extend the Mortgage Forgiveness Debt Relief Act (MFDRA). The MFDRA was enacted to alleviate the tax burden imposed on homeowners who were going through a short sale. Prior to this act, a homeowner would go through the short sale and sell his home for $200,000 when there was a mortgage balance of $250,000 on the house. The lender would then “forgive” the $50,000 that was outstanding. However, the Internal Revenue Service (IRS) would then sweep in and tax the homeowner on the $50,000 worth of revenue, which the homeowner was not able to pay.
In order to eliminate the negative tax consequences of a short sale, the MFDRA was enacted in 2007 and permitted the homeowner to avoid the tax liability. However, this act expired at the end of December 2013. For many people going through a short sale, there is no guarantee that there will be a two-year extension of the MFDRA, which would have to be retroactive to January 2014 to offer protection to everyone. Therefore, more people are considering bankruptcy in order to have more certainty about the outcome. As of August 2014, there was new legislation in the Senate that contains an extension of the MFDRA, but its passage is not a certainty.
Benefit of a Short Sale over Bankruptcy
Many times, a person or family faces the necessity of a short sale or foreclosure because of a temporary financial setback, but there is hope that they will be able to get back on their feet, economically-speaking, and then purchase another home. Short sales are by far more conducive to a quicker credit recovery, which permits a person to qualify for another mortgage.
There are standards in place for government-funded lending entities, such as Fannie Mae and Freddie Mac, for dealing with individuals who have suffered from a “derogatory credit event,” into which category a foreclosure, short sale, or bankruptcy action fall. However, the impact of the event differs dramatically. A person who has been subject to a foreclosure action, whether through a bankruptcy or not, may have to wait up to seven years for the opportunity to qualify for a government-backed mortgage. In contrast, a person who has gone through a short sale may only have to wait two years. Although these wait periods are not set in stone, it typically requires extremely compelling circumstances for a person to be approved for significant deviation from these time periods. These compelling extenuating circumstances usually involve a catastrophic event that is not in the control of the borrower and results in a significant loss of financial resources or increase in financial obligations. In essence, it is unusual for a person to satisfy this standard and most people have to wait the proscribed time period.
The time periods are shorter for a Federal Housing Administration (FHA) mortgage, where a person might be able to qualify for a new mortgage in one year after a short sale and up to three years after a bankruptcy and foreclosure. When a person is going through a short sale because he was enticed to purchase far more house than he actually could afford, but easily can manage the payments on a more reasonably priced house, this time disparity can make a huge difference.
Taub & Bogaty PLLC Represent Homeowners Contemplating a Short Sale
There are many questions that a person has when facing a short sale and our skilled and experienced New York Real Estate Attorneys are ready to sit down with you and discuss all the options in order to determine what works best for you. To schedule an initial free consultation, call us at (516) 531-2500.