A short sale sounds like a great way to take care of a foreclosure, right? Well you need to be careful. Many of my bankruptcy clients are somewhere in the short sale process. If you even think that you might need a bankruptcy, make sure to pay attention to these areas of concern:
First – It Could Prevent You From Getting A Full Discharge In Bankruptcy
Imagine going through a short sale and a bankruptcy and still owing a creditor tens of thousands of dollars. In order to understand how this can happen, you need to understand how mortgage creditors get paid in a short sale. A short sale means that your mortgage creditors get less than what they are owed. That creates a deficiency. Usually the first mortgage will waive the deficiency, because it couldn’t get a deficiency in a foreclosure anyway.
It gets tricky when you have a second or third mortgage. Those mortgages are going to get paid pennies on the dollar in a short sale, if anything at all. These are the mortgages that put your discharge in jeopardy.
Often times a second or third mortgage will require to to give them a promissory note before they agree to the mortgage. This is where you need to make sure you talk to a bankruptcy lawyer first.
If you take on a debt shortly before you file bankruptcy, and there is evidence that you never intended to pay it, then the creditor can file a lawsuit. That lawsuit can prevent the debt from being discharged in bankruptcy. If it comes to a lawsuit, you can’t just say “I always intended to pay them back.” That’s because in these cases the court will look for badges of fraud, basically circumstantial evidence that points to fraud. A couple of badges of fraud are that you were unable to pay the promissory note when you signed it or when you signed the promissory note compared to when you filed bankruptcy.
If the court finds those badges of fraud, then you would still owe those mortgage creditors. Is it guaranteed to happen? No. But if the banks start getting aggressive with short sale deficiencies, it could. If you have already signed a promissory note in a short sale, you can take steps to protect your discharge, but you should talk to an experienced bankruptcy lawyer.
Second – Make Sure You Get Good Advice
A bankruptcy attorney is charged with giving each client objective advice, without any regard for that attorney’s self interest. Why is that important? Because my advice is based on what is best for you and nothing else. On top of that, I spent three years in law school, clerked for a federal bar exam, and passed a three day bar exam. Most short sale specialists are not familiar with the law, especially not bankruptcy law. They may mean well, but they can’t identify areas of concern that a bankruptcy lawyer can spot in a heartbeat.
Third – Don’t Let It Delay Your Financial Recovery
People do short sales to keep foreclosures off of their credit report. The thing is, if your house is in danger of foreclosure you credit is a mess already. First of all, there are all the missed mortgage payments. Second, you are likely to have other debts that are hurting your credit score. In fact, having too much debt can hurt your credit score because it hurts your credit utilization ratio and your debt to income ratio. Add to that any missed payments or debts that are in collection, and every month, all of those late payments and collection items add another minus to your credit report. The bottom line, even if you do the short sale your credit score is still going to be a wreck.
Here’s the problem. Short sales can take a long time to close. During that time, your credit isn’t getting any better. Filing a bankruptcy and letting the debts on the house get discharged in bankruptcy can speed up your overall financial recovery. First all of your consumer debts, credit cards, medical bills, and mortgages will get discharged. Second, the monthly cycle of negative marks on your credit report stops. Finally, the bankruptcy discharge will immediately improve your debt to income ratio and your credit utilization ratio. So the sooner you can do a bankruptcy and take care of everything, the sooner you can start rebuilding your financial future.