How does bankruptcy affect the short sale

I’m in the beginning of working on my first short sale, with a divorced couple, and the husband declared bankruptcy last year to delay foreclosure. Prior to this, they attempted to do a short sale, but it did not go through at the time.

Since 2006, nothing has been paid by either the husband or wife, and the husband is still in the property.

They have two mortgages on the property both from the same lender. The lender was willing to form a modification program, but that is not going to work with the homeowners. They want out.

How would this bankruptcy affect the short sale, if at all? And what should I keep in mind?

The Homeowner is in Bankruptcy

First off you don’t ever want to offer legal advice to the homeowner unless under the rare situations where you’re a qualified attorney. Let’s discuss the two typical types of bankruptcies that you may encounter.

Chapter 7 - know as Liquidation

Chapter 13 - known as Reorganization

With either type you are going to have to contact the Trustee of the Bankruptcy to get the property released out of it.

You will need to get a letter called “Affidavit of Abandonment for Real Estate & Asset”
This letter will allow you to obtain clear title so you can close on the property with your buyer. Bankruptcy puts a hold or “stay” on the foreclosure process or any other debt collections period. This will continue until it is completed or a “release of stay” is issued by the judge for the lender or lender’s trustee to proceed with the foreclosure.

If you try to do anything with the homeowner while they are in bankruptcy it can be considered “fraudulent conveyance” since the asset (the property) you want to buy legally isn’t in the owners control at that time. In fact, their’s a Federal Law that states that ANY conveyance while the property is in the bankruptcy will not be valid! The bankruptcy has control over it. You see when a person files for bankruptcy the Bankruptcy Court will assign a Trustee/Attorney to manage the debt situation for the homeowner until it is discharged or dismissed.

The only way you can get the deed legally is stop the bankruptcy or get the Trustee of the Bankruptcy Court to agree to release it. You will need to contact the Bankruptcy Court Trustee or Attorney and tell them you have interest in buying the house. Most of the time if they deem the property has equity, they WILL NOT release it. That’s why it is vital to communicate with them about doing a short sale and the property it’s not worth what is owed on it. Therefore it essentially has negative equity. I have been through this process a lot and can tell you it IS NOT EASY…but doable. You will need to have all your contractor reports, appraisals, supporting documents ready to send to the Bankruptcy Court Trustee at a moments notice.
It usually takes a minimum of 20 days before you get an answer. That is of course if they aren’t backed up with other files in front of yours which is like…never. Before attempting this make sure the property you’re dealing with has a significant upside to it. I’d say at least $30,000 profit or you’re probably wasting your time. It can be profitable, but you must pick and choose your battles. Be sure and keep a pulse on how much time you have before the sheriff sale too.

If the Bankruptcy Court Trustee agrees to release the property from the bankruptcy you can expect the foreclosure process to begin very quickly. Keep a pulse on how much time you have to get it closed. It is best to have the buyer ready to go before getting the property released.

With cases in bankruptcy, I usually get the deed and all the other documents signed, but I DON’T FILE THE DEED until I know the bankruptcy is complete or dismissed.

One other thing: EVEN IF… the BK has been dismissed some title companies still need the “Affidavit” mentioned above filed by the attorney that filed the BK for the homeowner…or use another attorney, in order to get clear title.

Move on to an easier deal.