Understanding Foreclosure and Bankruptcy Implications

I've personally talked to bankruptcy attorneys who give you two options, chapter 7 or chapter 13; There's no consultation, and not even always accurate and correct advice. I had an attorney tell me two things that later turned out to be incorrect, and it could have cost me thousands of dollars!

Most attorneys: "That'll be $2,000 and we'll fix your problem."

WRONG! If your problem is your credit is too good, then that problem is solved. But seriously, sometimes bankruptcy seems like a good option because you don't have all the information, or sometimes the attorney will just push you onto it by scaring you with a bunch of legal-ese. But the bankruptcy does nothing to stop your foreclosure. And you can still end up with a foreclosure on your credit report (despite what your lawyer may say; they don't know any more about credit reporting than you do most of the time). If you are facing a foreclosure, this is a situation you definitely want to avoid except in the most extreme situations.

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In most cases, the best thing for you to do when facing foreclosure, assuming that your inability to pay the mortgage is not temporary, is to SELL THE PROPERTY AND SELL IT FAST!

In doing so, you will avoid having a foreclosure or a bankruptcy on your credit report. You'll be able to get on with your life and avoid having your foreclosure and bankruptcy haunt you for years to come!

There are two things to be on the look out for when using a short sale to sell your property. The first is the income tax implications. You may be '1099-ed' for the "Forgiven Debt", this is a capital gains tax on the 'Phantom Income' (when you sell for less than what you owe), unless the property is your principal residence, the mortgage was used to purchase or improve the property and the difference is less than $250,000. (This is not an all inclusive explanation, just a guideline; the tax codes are infinitely more complicated.)

The second thing to look out for is the possibility of a "Deficiency Judgment" brought on by the foreclosing lender, or PMI (Private Mortgage Insurance company). If they believe that you have assets, the lender may initiate the legal proceedings for a judgment in the amount of the money they lost due to the short sale. There are two items to note here:

The lender can only pursue a deficiency judgment if you have not signed a 'promissory note' agreeing to pay them money, or if they did not accept the short sale payoff as 'payment in full'. A deficiency judgment can be pursued by the lender (or PMI company) even if they foreclose on your property. Let me say that again. You can get a foreclosure on your credit and still be sued for the deficiency amount. If there is a foreclosure there are many more expenses involved, thus the deficiency amount is greater as well.

If you are unable to sell your property, or short sale it while avoiding a deficiency judgment, a bankruptcy may be a good solution, provided you have $2000 to pay an attorney AND less than $5000 in assets after paying the attorney's fees (anything over that amount will have to go to paying off your debt if filing a chapter 7). Of course you still could consider a chapter 13 bankruptcy filing where you are required to pay back some or all of your debts, but your foreclosure will be put on hold temporarily.

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