Short Sale or Bankruptcy: A False Choice?
Short Sale or Bankruptcy: Not Truly Alternative Options
"Should I walk away from my home through short sale or bankruptcy?" is one of the more common questions potential Chapter 7 or Chapter 13 bankruptcy clients in Michigan have asked over the past several years, since the national mortgage meltdown. The reason the question is asked is primarily because of false impressions created by the media and by the marketing of realtors and other interested parties that A) bankruptcy is immoral and will ruin your credit forever (visit our Bankruptcy Myths page for our response to these maniuplative and false suggestions); and B) a short sale is easy and will leave your credit intact. These latter two suggestions are just as false as those regarding bankruptcy.
Short Sale or Bankruptcy: What are the Downsides of a Short Sale?
The first thing to do in discussing the "Short sale or bankruptcy?" question is to pull the curtain back from the short sale process and take a look at how it really unfolds, who the players involved are, and what the real costs are in terms of continuing liability for mortgage deficiency amounts, realtor and attorney-negotiator legal fees, and, least discussed of all, taxable liabilities. A short sale is, first, simply the sale of a home for less than you owe for one or more mortgages (which do include home equity lines of credit and home equity loans) encumbering the property. People are interested in the short sale when they want or need to relocate from a house that, typically, is, in current market terms, worth less than is owed on it. This is the "underwater" state that people sometimes refer to. The first downside of a short sale is that it requires multiple parties who all want something out of the process, and it requires the permission of many of those parties to proceed. To short-sell a house, you need a realtor to process the sale, you need a buyer with an approved offer in hand, and you need, obviously, the banks or other entities holding the mortgage or mortgages on the home to agree to the process. Some attorneys offer a short sale negotiation "service" in which they (or, more likely, their unlicensed clerical staff) conduct the actual negotiation with the mortgage-holding bank, working with the realtor to accomplish the sale. This may present, by the way, a legal conflict of interest when the attorney becomes more concerned with closing the sale than with providing you, the homeowner, with the best, aggressive legal representation possible, a requirement of every state Bar Association in the U.S. Just listing these parties makes it clear that this is not a simple process with a predictable timeframe—or a predictable cost. The easiest part of the short sale is finding a realtor willing to earn a commission off of the sale of the home and a buyer willing to pay a low, market-friendly amount for the home. The tough part follows from that point. Banks (other entities than "banks" may hold mortgages—and, in fact, may be more likely than actual banks to hold mortgages, but we'll call them "banks" for simplicity's sake in this article) hold all of the cards in the short sale process. When you signed your mortgage note, you signed a legal contract (generally) obliging you to pay a certain amount of money to the holder of the mortgage over a certain period of time. The home itself is merely collateral securing the personal loan for the purchase of the home the terms of which are codified in that mortgage note. Banks have no legal requirement (leaving the recent National Mortgage Settlement and proposed guidelines by the new Consumer Protection Bureau out of it for the purpose of this article) to agree to let you out of that contract. Why should they? They have you where they want you: legally obliged to pay. Period. Even after a foreclosure, they can still collection from you in Michigan for the deficiency balance still owed, which is the difference between what the house sells for at the foreclosure sheriff's sale auction and what you owe under the terms of that mortgage note contract. Banks want something to agree to let you sell the house for less than you owe and to release their liens on the house to allow the short sale to go forward (every mortgage contract in use otherwise restricts sales of the home prior to full repayment of the mortgage loan). What they want, how much they want, over what timeframe, and even whether they will accept anything whatsoever and agree to a short sale at all are ALL subjects of a negotiation that must take place after you have found your buyer. Banks will require a lot of documentation from you, including items such as a "hardship letter," which is an explanation of your reduced circumstances and why they ought to take mercy upon you and agree to the short sale, proof of your income, expenses, debts, and other real estate owned. Remember Michigan Supreme Court Justice Diane Hathaway, now awaiting sentencing as of this writing for real estate fraud? She tried to hide other real estate that she owned in order to trick a bank into agreeing to allow her to short sale a Grosse Pointe mansion. She is now out of the cushiest job in America, will likely lose her license to practice law, and may face prison-time. Was it really worth it? Hard to see how. Michigan Supreme Court Justices and Grosse Pointe mansions and Florida vacation homes aside, the routine short sale is just as tricky and uncertain, particularly when you have a 2nd mortgage or home equity loan lienholder encumbering the property along with a first mortgage. It may be possible to get the first mortgagee to agree to the short sale, but then you have to get the second mortgage-holder to do the same. And they really do not want to let you off the hook because they have nothing to lose. If the underwater home goes to foreclosure, they will get nothing out of the deal as the first mortgage-holding bank will receive all of the proceeds of the sheriff's sale and the sale itself will remove all other liens (the second or third or other mortgages) from the title. Second mortgage-holders thus will take the opportunity of a short sale negotiation to wring out of you a large payment, an extended payment plan, or may offer nothing at all, simply agreeing to release their lien but still requiring you to repay them every penny owed under the terms of your mortgage note contract. What's the point in that? On top of that, depending upon the use you made of funds received from home equity loans or lines of credit (spent on home or not spent on home, etc.) and Congress' continuing renewing of the Mortgage Debt Relief Act and other factors, you may end up with taxable liability for the amount of the debt "forgiven" in the short sale negotiation. And all of this could just take a few months—or it could take a year or more. Or never work out at all. A significant number of major mortgage lenders are, as a matter of standard operating procedure and internal company policy, very unwilling to negotiate short sales to any truly beneficial-to-you extent. All negotiation that does occur occurs outside the purview of any judicial authority. The final factor regarding whether a short sale is better for your credit than a bankruptcy is not much of a factor at all. A short sale still constitutes a major negative reporting event, and so do the missed payments that generally lead up to a short sale negotiation. A short sale will still preclude for at least a few years from new mortgage borrowing. So, again, what's the point in that?
Short Sale or Bankruptcy: What's Good About Bankruptcy?
That all being the case, the "short sale or bankrutpcy?" question usually resolves itself in favor of a surrender of the property in question through a Chapter 7 or Chapter 13 bankruptcy, despite a couple of negative strokes on the bankruptcy side of the equation. You may surrender property in either a Chapter 7 or a Chapter 13 bankruptcy, however, in a finite amount of time (about 4 months in a Chapter 7 or through a 3-5-year Chapter 13 payment plan), at 0% interest, with NO requirement to negotiation ANYTHING with creditors, NO possibility of having to pay any of them another dime, and NO taxable liability at all—and all under the supervision of the Federal Bankruptcy Court which (generally) has your interests in obtaining a fresh start from unmanageable debt at the core of its mission. The surrender of property serving as collateral for a secured loan such as a mortgage note contract is simply one of the things that bankruptcy does. The moment you file a bankruptcy, you are protected from creditor harassment by the "automatic stay against collections," an injunction under Federal law that prevents any creditor from doing anything that constitutes the collection of a debt, including foreclosure. Upon discharge, the permanent discharge Federal injunction prevents anything of this sort permanently (although the bank will havae the right to foreclose to re-take title to its collateral, the house in question). All of this occurs with zero percent interested paid on any amount of the debt repaid, if any, through a Chapter 13 bankruptcy payment plan, and the discharge of debt in bankruptcy, unlike debt "forgiven" by settlement or short sale negotiation, is an entirely tax-free event. A bankruptcy will remain listed in the Public Records section of your credit reports for 10 years from the date of filing and will likely prevent you from obtaining new mortgage financing for around 3-7 years, depending on the steps you yourself take with regard to repairing your credit after the discharge. A bankruptcy will, most importantly of all, discharge not only the mortgage deficiency and other home-related debts but all of your other debts, too. A bankruptcy is a complete debt solution operating with the power of Federal law. A short sale will help you out, if at all, only with one, single liability: that mortgage on that house. It will leave you holding the bag for all of your other debt, your credit still in a state of disrepair. The Hilla Law Firm, PLLC has had, unfortunately, many, many clients who have been through a short sale only to end up filing bankruptcy anyway. If you are going to file a bankruptcy (especially if so because your mortgage-holder will not agree to waive collection on the post-short sale mortgage note debt deficiency in a short sale negotitation), there is no point whatsoever to the short sale. The bankruptcy will allow you to surrender the property safely, securely, tax-fee, and in a predictable timeframe with Federal court oversight.
Short Sale or Bankruptcy: Is Your House as Underwater as You Think It is? The Chapter 13 Bankrutpcy Lien-Strip
A further "short sale or bankruptcy?" question is whether your house is truly as "underwater" as you think it is. We have had clients who have explored a short sale due to an extreme lack of equity in a home due to the presence of one or more second mortgages on the property. If your property is worth only slightly less than you owe on a first mortgage and you would otherwise actually like to retain the property rather than surrender or walk away from it, a Chapter 13 bankruptcy will allow you to strip off that second mortgage entirely. A "lien-strip" in Chapter 13 bankruptcy is a process not available in a Chapter 7 bankruptcy (although a bankruptcy court in Florida has recently allowed it) which will allow the stripping off & discharge as if it were an unsecured (credit card, medical debt, etc.) claim of a second or subsidiary mortgage where the property alleged to secure it is of sufficient value only to secure or partially secure the first mortgage on the property. That is, if the house is worth less than you owe on first mortgage, other mortgages can be removed through the Chapter 13 bankruptcy with very little wiggle-room for the mortgage-holding creditors. You pay some of what you owe to all of your creditors through the Chapter 13, then emerge from the bankruptcy with only one mortgage on the home and no credit card or other unsecured debt at all. This is something that a short sale certainly cannot accomplish.
Short Sale or Bankruptcy: Key of the False Comparison
The key difference between a short sale or bankruptcy is that a short sale is an option while bankruptcy is a right. The power that you have over your own situation in bankruptcy versus the power that you don't have in a short sale negotiation springs from that crucial difference. If you are a Michigan resident and are considering filing for bankruptcy, please contact us at (866) 674-2317 or click the button below to schedule a free, initial consultation.