Real Estate and Bankruptcy – Interview March 2018

Welcome back to This Needs to Be Said, Attorney Drescher. How are you?

I want to branch out into two … There are two different roads to go down. One is the road you go down if you want to keep your home and the other is the road to go down if you’d just as soon not keep your home.

You’re looking at a deed in lieu of foreclosure or a short sale. In lieu of foreclosure happens when you are just going to say to the lender, “Here. Take the property back. Take the home back and relieve me of the debt.” And frequently, they will agree to do that.

The alternative is a short sale where you say to the lender, “Okay, look, I’m going to sell the property for less than what I owe you and you’ll agree to let that sale go through and then whatever is left on the mortgage, you’ll either forgive or we’ll work out something to pay it back.” Those are the two options if you don’t want to keep the house. Now the problem with both of those options is, first of all, if you have to pay the money back, that’s … I don’t know, I guess it depends. If you only have to pay back a small amount of money and you can afford it, a short sale is a great option for you and you don’t have to consider bankruptcy.

But let’s say that’s not your situation and let’s say you’re going to sell the house for way less than the mortgage pay off. Then you may really want to consider a bankruptcy because that gets rid of that deficiency. Some people say to me, “Wait a second, if I can do a short sale, and the lender will forgive the difference between what I sell it for and what the mortgage is, isn’t that great? Doesn’t that mean I don’t have to file bankruptcy?”

Well, my concern in that situation is a pretty nasty tax concept called Discharge of Indebtedness Income. And that’s a very, in my opinion, mean-spirited provision of the tax code.

But there’s a huge, huge exception to that rule, which is that if you discharge the debt in bankruptcy, you don’t pay tax on it. So because otherwise, bankruptcy would be a terrible thing. So you don’t pay tax on debt that is discharged in bankruptcy. So here’s the rule, instead of doing a short sale, do a bankruptcy first then do the short sale. Now you might say to me, “Why bother with the short sale if you discharged the debt? Just let the lender take the property back and let them foreclose.”

That is not a terrible strategy, by the way, but if you’re going to want to get into another home, sooner rather than later, and believe it or not most people who let go of their homes, they do. They want to get into another home that they’re going to be able to afford this time. They don’t want to make the same mistake this time that they made last time. They want to be a little bit smarter about it but they do want to get into another home. When you apply for a loan for the new home, they’re going to want to know how long it’s been since you owned a home that was your primary residence and if it’s been less than two years, you’re not going to get that loan.

So it makes sense for you to continue to try to do that short sale, not so you can be relieved of the debt but so you can get out from the house so that that two year time period starts ticking sooner.

Does that all make sense to you so far?

So now we’re going to go down the other road, and the other road is the loan modification road, what you need to do if you want to try to keep your house. This is another potential gotcha because what you’re going to do is you’re in default under that home loan. And that’s another thing, they won’t give you a loan modification unless you’re in default for at least 90 days. Because they might say, “Well, listen, you’re paying it as agreed, why should I give you relief from the loan?” So you have to fall behind. Sometimes people call that a strategic default but in my experience it’s just that people are really suffering hardship and they just can’t afford to make the mortgage payments.

So you’re behind. So, let’s say you’re behind 90 days. The lender is going to start foreclosure on that property. So depending on the state you’re living in, it could take a year, it could take nine months, it could take 60 days. In the meantime, you are applying to that lender to get a loan modification and what the loan modification will do, amongst some other things, is going to take all the money that you owe on that loan, all the arrears, and it’s going to add it to the principle balance. So that you’re starting from scratch but with a slightly higher loan and they’ll give you the best interest rate they can and hopefully that’s going to make it possible for you to stay in your home.

Now, the problem is … And that’s a great outcome. And that is a desired outcome and if you can do it, you should do it and not file bankruptcy. The problem is that while my clients are applying for these loan modifications to cure the default, the lender is moving forward with the foreclosure process. So there’s a two prong approach. There’s the foreclosure approach and the loan modification approach. And the left hand almost never knows what the right hand is doing.

But once they go through with the foreclosure sale, that loan modification is gone. It’s dead. They’re going to close that file and you’ll never have a chance to get a loan modification and you’ve lost the house.

A third option is, depending upon what other kind of debt you have, you stay in Chapter 13 and you just go ahead and you move forward with all the benefits that Chapter 13 offers. And that’s a discussion for a different time. You know, Chapter Seven or Chapter 13, that’s a different option but if you’re going to be going forward with a loan modification, you need to be prepared to file that Chapter 13. And even though you’re in a Chapter 13, the lender will still consider your loan modification application.

If they deny the loan modification, you’re not necessarily totally out of luck, because Chapter 13 does give you the opportunity to catch up and pay that defaulted loan amount over the life of your plan with is 36-60 months, but a lot of times my clients really can’t afford that. So a loan modification is a better alternative for them than a Chapter 13, but sometimes a Chapter 13 is your last best chance of holding on to that house.