Short-selling an underwater home is frequently touted as an alternative to New York bankruptcy, but sometimes the two go together. Debtors might find it dispiriting to hear that solving their mortgage problems might require two bureaucratic processes, but knowing how short sales and bankruptcy intersect can help debtors decide whether it’s necessary to take both routes or just one. The question is the timing of each.
Starting with bankruptcy after a short sale (because it’s easier), the debtor sells the home and then uses bankruptcy (usually chapter 7) to discharge any remaining debts. There can be many advantages for doing so because often debtors have significant non-secured debts even after the short sale. It’s not uncommon for debtors to try to put mortgage payments or association fees on their credit cards in the run-up to their short sales.
Sometimes, banks will cancel the deficiencies anyway, indicated by Form 1099-C, which banks send to debtors. If a bank cancels the deficiency from a short sale, then it counts as taxable income to the debtor.
Alternatively, sometimes debtors’ lenders won’t cancel the deficiencies on their mortgages, meaning they’ll still owe money on homes they don’t own. This problem can be amplified by owing home-equity loans or other junior mortgages that weren’t part of the short sale to begin with. Chapter 7 discharges all of these debts.
Another advantage of bankruptcy after a short sale is helping debtors regain their credit scores after an adverse credit event like missed payments or defaults. Bankruptcy typically raises credit scores, so it can help debtors get back on the path to homeownership more quickly too.
Then there’s bankruptcy before a short sale. New York bankruptcy lawyers will usually discourage this course of action because bankruptcy discharges debtors’ mortgages. This means that debtors are no longer personally liable for their mortgage debts, but the banks can foreclose if the debtors stop paying. Bankruptcy delays foreclosures, allowing debtors more time in their homes, but once homes are sold in short sales, debtors move out.
After bankruptcy, rather than try to sell the home (if they still can’t afford it), debtors could simply offer the deed in lieu of foreclosure to the bank and move on. Also, a bank won’t issue debtors in bankruptcy a Form 1099-C, which cancels their mortgage deficiencies, but debtors won’t need to pay income tax on the deficiencies because they’ve already been discharged.
The one reason to short-sell the home after bankruptcy anyway is if debtors want to buy a new home sooner rather than later. Debtors will usually try to qualify for a mortgage through a government-sponsored entity, like Fannie Mae, which establishes its own eligibility guidelines for borrowers after they suffer credit events. A debtor who files chapter 7 bankruptcy must wait at least four years before he or she is eligible for a mortgage under Fannie Mae’s guidelines. (That’s only two years for those who can prove “extenuating circumstances.”) However, if the debtor then goes through foreclosure, the waiting period jumps to seven years. A short sale, by contrast, brings it back down to four. Thus, debtors might want to consider a foreclosure alternative like a short sale if they want to own a home again in the future.
(Fannie Mae’s guidelines are here (pdf).)
If you are struggling with mortgage debt, then talking to an experienced New York bankruptcy lawyer can help you strategize your options.
For answers to more questions about bankruptcy, the automatic stay, effective strategies for dealing with foreclosure, and protecting your assets in bankruptcy please feel free to contact experienced Brooklyn bankruptcy attorney Bruce Weiner for a free initial consultation.
