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SHORT SALES AND BANKRUPTCY

Callers and clients often relate to me that they are in the process of or desire to do a “short sale” related to real estate they own.  Usually it relates to their residence property.  

What is a short sale?  A short sale is the sale of real estate; however the selling price falls short (is less than) the balance owed on the loan or loans against the property.

Why do a short sale? Frequently, a short sale occurs where the borrowing homeowner can no longer afford to pay the mortgage loan.  However, the lender decides that selling the property at a loss makes financial sense under the circumstances.  Thus, foreclosure is avoided which saves the bank money on expensive foreclosure costs, and the borrower avoids a foreclosure on his or her or their credit reports.  Furthermore, the resourceful realtor earns a commission.  Finally, the purchaser often obtains the real estate for a discounted price.

People in the short sale business claim that a short sale (instead of foreclosure) provides a shorter eligibility time and lower interest rates for new mortgage loan, and, further, a smaller reduction on a person's credit score.  

Why should a borrower not do a short sale? 

The sale might not eliminate all of the mortgage debt:  Depending on the terms of the sale, some of the mortgage debt might not be eliminated.  This is more likely the case if there is a second mortgage or second trust deed involved.

It harms your credit rating: According to some, short sale generally causes the same harm to your credit as a foreclosure or a bankruptcy.  Others claim that, while a short sale harms your credit rating, it is not nearly as severe as a foreclosure or a bankruptcy.

You might owe taxes a consequence thereof:  After a short sale, you will receive an IRS Form 1099-C.  This form will reflect the difference between the amount you owe on the loan and what the mortgage lender agreed to accept.  Generally, this difference or savings is considered taxable income to you.  However, there are exceptions which render the difference not taxable, such as insolvency and certain kinds of mortgage debt.  Therefore, before going forward with a short sale, seek advice from your tax adviser to determine what, if any, tax consequences there may be.

See article: Tax Consequences of Short Sale, Foreclosure, and Debt Settlement

Is a short sale a good choice before or after filing bankruptcy?

Generally, a short sale is unnecessary for the person filing a Chapter 7 bankruptcy.  A Chapter 7 discharge results in the 100% elimination of personal liability, if any, regarding the first mortgage, as well the second mortgage (for example HELOC loans, that is, home equity line of credit). Such discharge (debt forgiveness) eliminates the need to do a short sale.  However, even though your personal obligation to pay the mortgage debt is wiped out, the lender is still entitled to foreclose on the property because the mortgage lien survives the bankruptcy.  

A Chapter 13 bankruptcy  permits a debtor to keep the real estate and pay back the delinquencies or deficiencies over a period of time.  In some cases, the second trust deed can be "stripped" and, at the completion of the Chapter 13, be eliminated.

For a free and confidential consultation, contact southern California Christian bankruptcy lawyer, Matthew B. Tozer.

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