Saturday, March 20, 2010
Is a Short Sale Better Than Filing Bankruptcy?
Underwater loans and a difficult real estate market have made short sale of homes a popular alternative to bankruptcy or foreclosure. However, bankruptcy may be a better option than short sale. Homeowners, trying to do the “right thing” are learning that no good deed goes unpunished. The short sale of homes often causes more problems than it solves.
A short sale of real estate means that the property is sold for less than the amount required to pay debts secured against it. This type of transaction requires the cooperation of the primary lender and any other creditors to whom the property was pledged as security. Many lenders and practically all realtors are eager to participate in a short sale. It results in a commission for the realtor and liquidates collateral for the lender. It is the homeowner who often gets the short end of the stick.
There are three major problems for home owners in a short sale of their residence:
1) A short sale, that does not pay all debt against the property, may still leave a balance due that can be collected by the creditor.
2) A short sale can result in debt cancellation income that is reportable on the homeowner’s tax return. And,
3) A short sale resolves no issues other than the ownership of the home.
While there may be some benefits of a short sale, in many cases, if not handled carefully, it can do more harm than good.
Lenders will often release their secured interest to permit the sale of a home with too much debt. However, unless it is required by the borrower, lender paperwork often leaves the issue of the unpaid balance unresolved. If the borrower is not released from the debt and the unpaid balance is not extinguished, the note can be transferred to a collection agency or other party for collection. This is particularly true in cases where there is a second lender that is paid nothing to release its lien on the home.
If the short sale occurs before December 31, 2012, and the loan for which a part was extinguished without payment was used exclusively for purchase or improvement of the home, The Mortgage Forgiveness Debt Relief Act of 2007 will exclude cancelled home loan debt from income. That law, originally scheduled to expire December 31, 2009, has been extended by congress through the end of 2012. It protects a homeowner from up to $1,000,000 in debt cancellation income or up to $2,000,000 if a married couple. The property must be the primary residence of the borrower.
The fact remains that many homeowners who fall behind on their home loans or who face home loan debt that substantially exceeds the value of their home have other debt problems. A short sale of the personal residence only relieves them of the debt associated with the home. It does nothing to address other consumer debt that may be draining family financial resources.
While bankruptcy is not a solution to all problems, it resolves most consumer debt problems at the same time. It also eliminates the problem of tax on income derived from cancelled debt and prevents holders of unpaid notes from later collecting the balance that remains unpaid. Those notes can still be collected in many cases along with interest and attorney fees or other collection costs.
A Chapter 13 bankruptcy can be used to bring a defaulted home loan current and rescue it from foreclosure or even remove a second loan from the home under the right circumstances. Only an experienced bankruptcy attorney can properly advise you as to the best course of action.