Home Short Sale After Chapter 7 Bankruptcy: Why They Often Dont Go Together
Updated: Feb 8
I am often surprised how many chapter 7 bankruptcy debtors who want to file bankruptcy just before a foreclosure sale to stop the sale, ask the following question: Can I short sale my house after I file bankruptcy?
Although it can be done, it rarely makes sense. The reason is because a home mortgage short sale after filing chapter 7 bankruptcy rarely makes sense.
When I ask clients why they want to short sale their house after filing bankruptcy, the response I usually get back makes clear that the debtor does not fully understand the ramifications of their bankruptcy filing and the relief it afforded. Unless a chapter 7 debtor reaffirms their secured debt in the bankruptcy, then the debt is discharged.
For example, lets say the debtor owns a house worth $130,000 and has a mortgage at $150,000. The house has negative equity, so if the debtor was not filing bankruptcy and wanted to get out from the house, the debtor would have to either sell it for a $20,000 loss and pay the difference at closing or get the bank to approve a mortgage short sale to forgive the deficiency.
However, now take the same numbers, but put the debtor in a chapter 7 bankruptcy. In this scenario, the debtor does not have to worry about trying to get a short sale approved to cover the deficiency, because the debtor can simply choose not to reaffirm the mortgage within the bankruptcy. By not reaffirming the mortgage, there is no balance owed to the bank, and the debt is discharged in the bankruptcy. Since the debt is discharged in the bankruptcy, then there is no incentive for the debtor to work a short sale, as the debtor can walk away without financial repercussions as to the note at any point.
It is important to distinguish that the lender only loses its rights as a creditor on the mortgage note when the debtor does not reaffirm. The lenders lien remains, so the lender can still foreclose on the property, and the debtor does not own it free and clear. However, since a debtor makes no money in a short sale anyway, why would the debtor bother trying to conduct a sale that makes no money when the debtor can pack up and move just as easily for the same no profit scenario?
The primary scenario where it might behoove the debtor to conduct a short sale either during or after a chapter 7 bankruptcy is when the debtor has been working with a realtor for a good bit of time on a short sale prior to filing bankruptcy, but was unable to complete the sale prior to filing. The debtor might feel some incentive to get the realtor a commission by conducting a sale, as opposed to just letting it ultimately go to foreclosure. It is important to note in this scenario that it is the realtor, and not the debtor, who gains. Furthermore, the debtor will still not want to reaffirm the note in this case, as the note does not need to be reaffirmed for the debtor to sell the house, because the debtor would still be on title. Finally, the debtor would have to check with an accountant to verify there would be no tax consequences in this sale, particularly if the debtor is trying to sell an investment property.
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