Los Angeles Bankruptcy Attorney Explains: Short sale or Foreclosure – Which is Best?

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Even after your bankruptcy discharge, you may have questions regarding your mortgage or other secured debts that pass through bankruptcy. Sometimes these secured debts aren’t resolved for months or even years after bankruptcy.

As a Los Angeles bankruptcy lawyer, you can image that I often get questions like the one below that I fielded recently. I was asked whether it is better, after bankruptcy, to simply let a bank foreclose on your unwanted real estate (in California) or whether you should pursue a short sale. Here’s the question:

Leon, I filed Chapter 7 and got my discharge early last year. I kept my home and let go of my investment property. It took a long time for the bank to deal with my investment property, even after I stopped payments. But I finally received a letter from the bank asking me which I would opt for—a short sale or foreclosure. Since the debt has already been discharged, is there any advantage for me in going through a short sale? Or, simply put, in California, after a discharged bankruptcy, short sales or foreclosure? Thanks for your answer!

Here’s my answer: I tend to shy away from the idea of a “short sale” after a bankruptcy is discharged. The reason is because your credit is probably trashed anyway, and the short sale transaction is still a voluntary sale on your part that may create future liability against you. As a seller in California you are required to give certain disclosures to the buyer. Hence, the transaction creates a possibility of future “risk” to you, but without any offsetting compensation to you for taking the risk because the transaction pays no cash to you. Let me explain this in more detail.

As an example of the risk, suppose the short sale buyer finds something wrong with the property that you failed to disclose. It might even be something you really didn’t know about, but a vindictive buyer might say that you did know. Either way, you could be sued, and the buyer could allege that you knew about the problem and that you were deceitful and failed to disclose it.

Your bankruptcy can’t protect you from such a claim or lawsuit because the sales transaction occurred AFTER you filed your bankruptcy. On the other hand, in a foreclosure, you don’t make any new representations about the property and you don’t participate in any escrow or other new transaction. The lender is simply completing a foreclosure sale (on debt that is discharged) after which the lender will have to re-sell the property to a new buyer. This is why I say that when you do a short sale you are taking on potential liability without any compensation for the risk.

And there are other risks in a short sale that you might not even see. Most people who suffer a foreclosure or short sale have not had enough money to adequately maintain their property over a lengthy time period, and there are often lots of defects, such as water leaks, mold, electrical problems, broken appliances, defective tile, drainage problems, foundation settling, broken air or heat, etc. Even in a condominium, there could be unfunded liabilities owed by the HOA, problem neighbors, or issues already known about that will require a future special assessment. The end result is that there may be expensive issues that will confront the buyer.

Human nature being what it is, people have a natural tendency to try and find someone else to pay for their problems. Many times an unhappy buyer will sue a seller because you are the party that sold them the property, and they think you sold them a lemon. Even if the risk is minimal, why do you want any risk at all, especially when you get no money out of the sale?

Is there an upside to doing a short sale in this situation? I can’t think of any, other than speculation that maybe it can make your credit look a little better? My view might be different for someone else, if no bankruptcy had been involved.

Lastly, I suggest that anyone in this situation get advice from a good CPA (tax specialist) just to make sure there are no unexpected tax issues that go along with either the foreclosure or a short sale.

So, simply put, I would prefer the foreclosure to avoid new risks and liabilities that might arise from a short sale after bankruptcy. I hope this information helps folks. But remember, for your particular situation, you must seek advice directly from your lawyer and your tax advisors. Good luck and be safe!

Bayer, Wishman & Leotta is a full service bankruptcy firm. We have offices in Downtown Los Angeles, the San Fernando Valley and Long Beach, California. Our attorneys are Certified Specialists in consumer and small business bankruptcy and you may reach us at (800) 477-3111. Check us out on AllExperts.com. Also, for lots of valuable bankruptcy information, look for us at TheBankruptcyGuide.net, our Human Guide to Bankruptcy.