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Short Sales or Foreclosures: Which is Better?
By Mark Markus | September 18, 2008
There is an epidemic of people defaulting on their mortgage payments, as everyone knows. Real estate brokers are pushing hard to have people do “short sales” on their properties, instead of allowing them to go to foreclosure. In most circumstances, this is a very bad idea.
What is a short sale? A short sale occurs when you want to sell your property, but owe more to the lienholders (mortgages) on your property than a buyer is willing to pay to purchase the property. As a result, one (or more) of the lienholders secured by your property must agree to accept less than 100% of what is owed to them, in order to allow the sale to proceed. But who does this benefit? Certainly the mortgage broker, because he/she gets their commission.
Historically, a short sale was used in these circumstances in return for an elimination of any obligation that the seller has and an agreement that no negative marks will appear on their credit report as a result. NEITHER of these is true today. I am seeing increasing numbers of people who do these short sales, and then the lienholder who didn’t get paid in full seeks to collect from the seller for the deficiency amount. On top of that, the short sale appears on the credit report in the form of a negative defaulted loan mark.
Furthermore, doing a short sale can sometimes affect the ability to relieve the seller of certain tax burdens if they subsequently file a bankruptcy case.
Compare this with the foreclosure process. You end up with the same liabilities and negative credit marks, but you can usually live rent-free in your home for months, if not years, while the lenders go through the foreclosure process. Most lenders will wait as long as possible to foreclose in today’s market.
This is an extremely complicated area of law involving both tax and bankruptcy law, but suffice it to say that the optimal strategy is that if you are going to file a bankruptcy, it is usually best to allow your property to go to foreclosure, and file your case before the foreclosure sale takes place (and, even better, have the foreclosure sale occur DURING the bankruptcy, but this is difficult to achieve).
Topics: Bankruptcy Law, foreclosures and short sales, means test, real estate issues | 3 Comments »
3 Responses to “Short Sales or Foreclosures: Which is Better?”
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February 26th, 2010 at 12:36 PM
Hi there, in the above article you note that “the optimal strategy is that if you are going to file a bankruptcy, it is usually best to allow your property to go to foreclosure, and file your case before the foreclosure sale takes place”
Questions:
1. Can you elaborate on the benefits or reasons to file Chapter 7 before a foreclosure is completed?
2. I understand that in chapter 7 the underlying notes are wiped out with discharge, but the mortgage liens remain. If this situation, would you just walk away from a house in California (note: house was in construction and only 90% complete) and let the bank foreclose or try to shortsale? Also, what if the lender does not take any action to foreclose?
February 26th, 2010 at 3:09 PM
This is a very complicated area of law and related primarily to taxation issues post-bankruptcy. The timing of the bankruptcy case in relation to whenever a sale takes place (whether it be foreclosure, short sale, or regular sale) can be very significant, particularly where the debtor owns multiple properties. It has to do in part with the debt being converted from non-recourse to recourse, and capital gains issues which can also flow from the sale. The short answer is that you need to consult with a tax attorney who has knowledge of bankruptcy to get a complete answer to your question.
Your assumption in #2 is correct: a discharge in bankruptcy eliminates the obligation of the debtor to pay on the mortgage debt(s) but the liens remain against the property. But again, the timing of when the bankruptcy is filed in relation to said sale can be critical. (there is also the issue of the debtor/taxpayer using the “short year election” for their taxes). If the lender never forecloses, then there is no sale and no taxable event, to my knowledge.
March 17th, 2010 at 12:17 PM
Thanks, I also came across another interesting article at: http://www.lonestarlandlaw.com/Deeding-Property.html where it talks about just deeding a property back to the lender (not deed in lieu). Have you come across this or do you know of any cases in California where this has been done? As if a person had discharge from their Chapter 7, I am trying to determine if this would be an option for them and what / if any ramifications there could be?