Tuesday, May 25, 2010

Dealing with House Debt: Short Sales, Foreclosures & Bankruptcy - Part II

In this Three-Part Post, we will evaluate some of the different methods of dealing with real estate debt when a mortgage modification or forbearance agreement is not an option.
  • Part I addressed the most common scenario which forces a homeowner/borrower to consider how to deal with property he or she can no longer afford.

  • Part II will address short sales and their interactions with Bankruptcy.

  • Part III will address "walking away" from a property through bankruptcy, and the resulting foreclosure by the lender.

Part II: Short Sale (and maybe Bankruptcy)

In a short sale, the bank or mortgage lender agrees to discount a loan balance because of an economic or financial hardship on the part of the borrower. The home owner/debtor sells the mortgaged property for less than the outstanding balance of the loan, and turns over the proceeds of the sale to the lender. Borrowers are able to mitigate damage to their credit history, and partially control the debt. It does not extinguish the remaining balance unless settlement is clearly indicated on the acceptance of offer. The borrower must work directly with the lender to seek approval of the short sale by the bank, obtain a purchaser, and complete the transaction before any foreclosure proceedings are completed. (In some cases, the bank may have initiated foreclosure proceedings, in addition to contemplating consent for the short sale.) Timing is critically important, and the debtor is an important part of the short sale process.

Short sales are a type of settlement, and they adversely affect a person's credit report, though the negative impact may be less than a foreclosure. Depending upon other credit information, it may possible to obtain another mortgage 1-3 years after a short sale, or even sooner if the borrower is current at the time of the sale.

However, if the individual does not then pay off the deficient portion of the mortgage (the unpaid portion of the mortgage after the short sale proceeds were applied to the balance), the lender can take further legal action against the debtor to collect the unpaid portion of the mortgage, which may include trustee process attachments, garnishments, or seizure of other assets, depending on the debtor's other property. The debtor may, after the short sale is complete, file for Bankruptcy upon completion of the short sale to discharge any deficiency and extinguish any further liability to the lender.

In this scenario, a foreclosure will never appear on the debtor's credit report. Although the Bankruptcy and Short Sale will appear on the debtor's credit report, some members of the mortgage lending agency will extend first mortgage financing, and even sub-prime mortgage financing, to prospective borrower with a bankruptcy that did not involve mortgage debt in as little as 3-4 years after the bankruptcy, provided the debtor has reestablished credit and used it responsibly during that time. Even if the bankruptcy included a small portion of mortgage deficiency debt, the fact that it did not include a foreclosure action will result in the debtor's credit healing much more quickly than if the debtor also went through a foreclosure during or before bankruptcy.

Deciding which option to pursue can be a daunting challenge for many individuals. Don't go alone. An attorney with Kelsey & Trask, P.C. can help you make these difficult decisions, and help you with the process. For an initial consultation, click here, or call 508-655-5980.

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