19 Oct Bankruptcy as an Asset Protection Tool – Part 2
In Part 1, we explore “bankruptcy for the rich.” As I stated, at least half of my clients these days are in complete control of their financial picture, with one glaring exception – that underwater house.
It is said that bankruptcy is merely a “tool” in the toolbox, meaning that, when used correctly, it gets the job done, and that it is often used in conjunction with other “tools” to complete a project. This analogy is especially true for underwater homes.
C’MON BANK, LET’S MAKE A DEAL
I have written extensively about the Chapter 13 Mortgage Modification Mediation Program and how bankruptcy leverage gives homeowners the highest probability of a meaningful mortgage modification.
Under the threat of sanctions, the mortgage servicing industry actually cooperates with the homeowner to rewrite the home loan. As this phenomenal program matures, the judges and the banks are becoming more receptive to the process, and the results continue to outpace non-bankruptcy modification applications.
We have many examples of meaningful modifications that succeeded only because the homeowner invoked the power of the Federal Bankruptcy Court and demanded that the mortgage servicer comply with its obligation to modify.
IS THAT A HOME OR AN ALBATROSS?
Sometimes, the best decision is to walk away from your home or investment property. For instance, In Florida, many homes are still 25% or more underwater, and Fannie Mae and Freddie Mac STILL do not allow for the reduction of principal balance in a modified mortgage. Modification without reduction makes absolutely no sense for many Floridians.
Chapter 13 of the Bankruptcy Code allows debtors to surrender any secured collateral, including cars, RVs and houses. In some bankruptcy courts, like the Jacksonville Division of the Middle District of Florida, a debtor has the opportunity to surrender this collateral “in full satisfaction” of the secured debt.
For example, when a Chapter 13 Plan is approved by the Court at a “confirmation hearing,” and that plan surrenders a house “in full satisfaction” of the debt owed to the bank, the bank can never seek a deficiency, and if a bank files a 1099 with the IRS for “debt forgiveness” the IRS does not consider it income to the debtor/taxpayer.
I SURRENDER! NOW WHAT?
Once the house is successfully surrendered in bankruptcy, the debtor should consider short selling it. The State of Florida is a “lien theory” state, meaning that, when a buyer purchases a home, he or she gets actual title to the property, and the bank takes a lien (known as a mortgage). The lender must go through the process of foreclosure in order to get title to the property, free and clear of all inferior interests and liens. The upshot is that, even having surrendered your house in bankruptcy, you will still end up with a foreclosure on your credit.
“So what?,” you ask. Well, the largest underwriters of residential mortgage, Fannie Mae and Freddie Mac, have stated that they will consider underwriting a mortgage for someone who short sells their home two years after the sale, even with a bankruptcy on your credit. By contrast, you must wait up to five years after a completed foreclosure before they will underwrite that same mortgage.
It’s clear that Fannie and Freddie view the foreclosure worse than either a short sale or bankruptcy, and because the debt has been eliminated in bankruptcy, the lender knows that it cannot demand that the homeowner come to the closing with cash. Therefore, the bankruptcy actually “greases” the short-selling gears by streamlining paperwork, resulting in faster closings.
Considering the relative ease with which a bankrupt debtor can short sell (as compared to anyone who has not filed a bankruptcy), the short sale should typically be part of a surrender strategy.
If your home or investment property is preventing you from kick-starting your post-recession finances, talk to a qualified bankruptcy attorney about modifying your mortgage or surrendering your home.
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