When your debt is unmanageable, it's essential to look for a way to get out of your situation. If you are behind on the mortgage and in the risk of foreclosure, it's sensible to sell the home. Even though selling the house means you won't keep the home, the short sale will avoid the pain and embarrassment that comes with foreclosure. To learn more about a short sale, bankruptcy, and short sale deficiency, read this article prepared by San Diego Bankruptcy Attorney. We are dedicated to assisting you to get the most effective solution to the financial challenges.
What is Short Sale Deficiency?
If you are having challenges paying your mortgage, a short sale could be a perfect solution. In a short sale, a person sells their house for an amount that is less than the debt balance. The creditor takes the proceeds and releases the lien on their home. Then the sale proceeds clear the part of credit owed. A short sale is one method you can use to stop foreclosure.
Since the selling price is lower than the total debt amount, the difference between the selling price and the debt is called a deficiency.
For instance, your creditor approves that you can sell your home for three hundred thousand dollars, but you are indebted to four hundred thousand dollars on your mortgage. The one hundred thousand dollars difference is the deficiency.
Unlike many states, lenders in California are prohibited from seeking a judgment against a borrower after a short sale to get the total deficiency amount.
Deficiency Judgement After a Short Sale in California
As previously mentioned, it is illegal to file a deficiency judgment after the short sale of a residential home with units not exceeding four.
Moreover, per Cal. Code Civ. Proc. § 580e, junior lienholders are banned from seeking a judgment if they agreed to the short sale. However, if you damage the asset or engage in fraud, the lender could take legal action against you.
It is worth noting that this law does not apply to borrowers who are:
- Limited partnerships
- A political subdivision of the state
- Limited liability companies (LLCs)
Additionally, the lender cannot require you to pay additional compensation apart from the short sale proceeds, in return for issuing written consent to the property sale. Therefore, your creditor should not require you to contribute money or sign a promissory note at the escrow's end as a short sale condition.
What are the Tax Implications If Your Creditor Forgives the Short Sale Deficiency?
In this case, you are obligated to repay your creditor. Usually, the creditor is supposed to report the forgiven debt amount and then issue you with a Form 1099-C. The forgiven debt should be considered your taxable income.
Mortgage Forgiveness Debt Relief Act (2007)
You could be in a position to escape liability for the short sale deficiency if you satisfy the Mortgage Forgiveness Debt Relief Act (2007) requirements. The act permits you to exclude a few categories of pardoned debt from your taxable income, provided you use the pardoned debt to:
- Build, purchase, or significantly improve your principal residence
- Refinance the debt resulting from those costs
Please note, the exclusion applies to debt forgiven between 2007 and 2017 or debt cleared in 2018 if an agreement (written) was entered in 2017. The exclusion does not apply to other real estate loans such as second homes or loans that weren't used for real estate, for instance, a homeowner took out their home equity loan and used the money to clear a credit card debt.
You could exclude up to one million dollars of forgiven loan or two million dollars if you're married and wants to file joint tax returns.
Which the Best Debt Relief Option: Short Sale vs. Filing Bankruptcy
What is the most effective debt relief option to stop foreclosure is a common question asked by homeowners struggling to be current on their mortgage. Two of the choices you can consider can be filing bankruptcy or short selling your home. Both options are helpful. However, which is more useful depends on your circumstances, including:
The short sale process can take a lot of time. Additionally, numerous parties should be included during the negotiations, and there is no guarantee you will close the sale.
Filing bankruptcy, on the other hand, offers you immediate relief from the debt since the automatic stay stops creditors from contacting you.
Are you Overwhelmed by Your Debt?
A short sale could be the best option if the mortgage is the only debt overwhelming you. Nonetheless, if you've other debt on top of the mortgage, filing bankruptcy allows you to handle the medical debt, credit card bill, among other debts at once.
Bankruptcy and Short Sale Deficiency
If you are contemplating a short sale, you probably have many questions. How is foreclosure different from a short sale? What will happen if you file bankruptcy? The benefit of proceeding with the short sale subsequent to filing bankruptcy will depend on the bankruptcy option you decide to file.
Chapter 7 and Short Sale
In case you file Chapter 7, and you want to short sell your home, there is no need to go ahead with the short sale.
The short sale is designed to relieve you of the obligation to clear the variance between your home selling price and the loan amount when your home's worth is less than your loan, or your home is underwater.
Chapter 7 gives you the option to surrender your home back to your creditor without the responsibility under your mortgage and no equivalent tax liability for your debt forgiveness.
That means if you're planning to file for this bankruptcy option, there is no need to go through the short sale negotiation stress. Nevertheless, if you reside in a region where houses are underwater, and there is an accumulation of forecloses, it is sensible to undergo the short sale as a way of getting the title off your name. If a property is surrendered through bankruptcy, the creditor will foreclosure to take away the homeowner's responsibility for the homeowner's association (HOA) dues.
The Relationship Between Chapter 13 and Short Sale
Short sale bankruptcy is different in this option. It permits you to surrender your home. However, the remaining deficiency will be cleared as unsecured debt via the repayment plan.
Although you will surrender your home, your lender is supposed to foreclose to clear your title. The foreclosure process will lead to the selling of your home. If the selling price is lower than what your total mortgage balance is, a deficiency results. Generally, Chapter 7 gets rid of unsecured debts, including deficiencies.
In Chapter 13, on the other hand, the deficiency is cleared as unsecured debt. Since you should clear off some of your unsecured debt via the repayment plan, the short sale, which reduces your debt before filing bankruptcy, remains helpful. Consequently, if you could negotiate a short sale before filing Chapter 13, you will lower your payment plan by reducing your unsecured debt.
Is Short Selling Your Home After Filing Bankruptcy Essential?
Did you file bankruptcy and are now thinking of a short sale? Or have you received a call from a real estate agent letting you know that somebody wants to purchase your home, but it has to undergo short sale so that the deal can close?
Before you short sale your home after filing for bankruptcy, read on to get the reality into your circumstances.
After Bankruptcy You are Accountable on Your Mortgage
If you underwent bankruptcy and received a discharge, you are not accountable for the deficiency resulting from your mortgage. If your home gets into foreclosure following bankruptcy, your lender cannot seek to collect the balance from you.
If the lender repossesses the property, it is their problem. You may sign off on deed returning home following bankruptcy, but it is up to the lender to come to you.
Homeowner's Association May Change the Game
Per Section 523(a)(16) of bankruptcy law, homeowner's association charges that come up after filing bankruptcy aren't discharged. In layman's language, all HOA charges that rise from when you file bankruptcy until when the home is not under your name, the meter is still running. If you are going to give up your home in bankruptcy, you are theoretically going to pay a lot of money after bankruptcy.
Often the homeowner's costs which accrue between a foreclosure sale and your bankruptcy filing will not affect you. To dispose of the home, the bank should clear the debt on the house, including HOA fees. Otherwise, no one will purchase the home.
Then the mortgage company clears the homeowner's fees after bankruptcy, which increases the money you owe your lender. However, the debt was discharged in bankruptcy. Again, this is not your problem.
Short Sale After Filing Bankruptcy Isn't Necessary
You will be required to enter into a contract when selling your home. You will also need to take the contract to the bank that will review it and get the property's appraisals.
If you engage a workout expert, you will most likely spend money to close the deal. Therefore, you will not benefit from it. The only individuals who win when you short sale your home after bankruptcy include:
- Real estate agents who make commission upon selling your home
- The buyer and workout consultant who purchase the asset at a more affordable cost than it should be
So, what takes place if there is a foreclosure after filing bankruptcy? You will be required to relocate. Also, until your creditor seizes the property's title, you will be required to keep current on insurance and taxes.
Effects on Credit
Short sales hurt borrowers' credit scores. Contrary to the common belief, the harm caused is as bad as a foreclosure. Additionally, you may not be in a position to obtain a new mortgage for years.
According to a FICO banking analysis, a short sale could reduce your score by eighty-five to one hundred and sixty points. If your score is better, the more significant damage the short sale could cause the score. Also, a short-seller who began with a higher score take longer to rebuild their credit.
Although it may take several years to recover fully, that does not mean you will wait for long before you get another mortgage for another home.
Hinging on the details of the circumstances, you could obtain a new mortgage within 2 or four years after your score begins to recover.
Generally, recovery begins once you are done with the short sale transactions.
How To Rebuild You Score
First, you should obtain a 1099-C from the creditor. That is why it is essential to hire a bankruptcy attorney early. The attorney will help you in debt forgiveness negotiations in your short sale agreement.
- Once you are done dealing with the deficiency, rebuilding your credit score is relatively simple. Start with requesting your credit report and analyze it for mistakes. Be sure to get the report from at least three main bureaus and check for inconsistency.
- Also, make sure you pay your bills timely. After a year or two of on-time consistent payment, you will notice your score will start to improve.
- Do not cancel your credit cards. You should restore the good credit score by showing your capacity to keep current on payment as well as debts low.
- If you cannot get a credit card, you could be eligible to obtain a secured credit card. A secured credit card will require you to deposit money available on your card. In other words, if you open a secured credit card with five hundred dollars, the credit limit will be five hundred dollars. Unlike debit cards, secured credit cards report your card activities to major credit bureaus hence assisting in rebuilding your credit.
- Rebuilding your credit score is one of the steps you should take when recovering from the short sale deficiency if you plan to purchase another home. You must also begin saving for the down payment you will require when acquiring a new mortgage. The amount of the down payment is essential as far as how soon you will get another loan is concerned.
While you can obtain a new loan after a couple of years, that doesn't remove the short sale impact from history. Any delinquent payment to the mortgage account shall be on the credit report for 7 years.
Why You Need to Engage a Lawyer
The difference between a real estate agent and lawyer as far as a short sale is concerned is that a lawyer will both negotiate your short sale and offer you legal advice concerning the transaction. The lawyer will also assist you in filing bankruptcy.
Discussed below are the reasons why you should consult a lawyer:
Cut the Deal
Before going ahead with the short sale, you should approve it with the creditor. Otherwise, they might come after you later with a deficiency judgment to get what you owe on the property, even after selling it. Your lawyer should assist you in negotiating with the creditor and making sure they agree on the short sale.
Assist You in Understanding Your Short Sale Agreement
All short sale documents have legal consequences and interpretations. However, the terms are not clear to any person without a legal background. It is also easy to miss essential information that might later cause you trouble. For instance, you may think that the approval letter from your creditor lets you off the hook for your deficiency. However, in the real sense, it does not.
You should ensure you understand the agreement so that there are no surprises after closing.
You Think Your Creditor will Foreclose
Should a short sale process fail, your creditor could seek foreclosure against you. Your experienced lawyer will analyze the foreclosure papers and then advise you on the various available options should it take place.
Avoid Deficiency Judgement
Your attorney should also assist you in handling or avoiding a deficiency judgment. In California, a lender is prohibited from seeking a deficiency judgment against a homeowner who short sale their home.
Any experienced legal expert will tell if you are in danger of a deficiency judgment. They can also assist you in filing for bankruptcy as a way of avoiding judgment.
During your initial consultation, collect your financial records and list all your liabilities, debts, and assets so that the attorney may have an understanding of your financial situation. A short sale process is complicated, and it is essential to have an expert who has your best interest at heart on your side.
Find a San Diego Bankruptcy Lawyer Near Me
If you are behind on your mortgage payment or your home is severely underwater, you may think a creditor approved short sale is the best solution. However, like many homeowners, you might find out that liability for the entire mortgage balance does not end after the short sale because of deficiency. Although it is illegal for your creditor to pursue a deficiency judgment, it is essential to have an attorney who will ensure the creditor complies with the law. At San Diego Bankruptcy Attorney, we can assist you with negotiations and include a clause in the agreement that your creditor cannot seek a deficiency judgment against you. Additionally, we can advise you on whether a short sale or filing bankruptcy is the best option given the circumstances. For more information, call us today at 619-488-6168.