Category Archives: Bankruptcy

RIP: Illinois short sales

The year 2014 is here and short sales are the year’s first casualty. They are dead on arrival. Gone, done. The final nails in the coffin were the expiration of the Mortgage Debt Forgiveness Act (MDFA) and the sudden increase in deficiency judgments in Illinois during late 2013.

Now, I recommend short sales to almost no one.  Three reasons you should NOT do a short sale.

  1. Deficiency Judgment may be entered. To get a short sale approved you generally have to be behind on payments. Once you stop making payments and try a short sale, there is a 50% chance that it will close. If it does not close, it will end up being foreclosed and there is a strong possibility that a personal deficiency judgment will be entered against you. Not fun.
  1. You will get a taxable 1099 EVEN if the short sale closes. Many, many short sales do not close and end up as foreclosures. If you are foreclosed upon, there will be a 1099 issued even if the property was your primary residence. The MDFA expires on December 31, 2013 and this means that tax is owed on the 1099 issued after a short sale. Why would you do a short sale if you have a huge tax bill on the back end? Due to the 1099, it makes no sense to do a short sale (unless you are insolvent.
  1. Process is too difficult. I closed a lot of short sales in 2013. We became pretty good at getting some of them approved, but we still lost quite a few. The process is even worse now. Many lenders “service release” a mortgage to a new lender in the middle of a short sale. It seems that the new lender is almost always Bayview Loan Servicing. That means you get to start the short sale over again. Bayview has a crazy process and requires that it “net” 95% of the broker price opinion (BPO) amount. Considering the real estate commission is 6%, how are they supposed to net 95%? The buyer has to agree to pay more than the BPO for the closing to happen. If they net less than that, Bayview requires that the property be listed, which is an online auction site. The chances of closing one of these is slim.

The Chicago Sun Times had a nugget yesterday that 25% of Chicago area homes are deeply underwater. What are these people supposed to do now? With the death of short sales, there are two options: Stay in the home until the value increases or file bankruptcy.


The costs of skipping a house payment








What kind of damage to your credit happens after 1 missed mortgage payment?

Oddly, it depends on if you have good or bad credit to start with. Those with good credit suffer more than those with bad credit.  (Answer: It’s about a 60-100 point drop in your FICO score for one missed payment.)

This great post talks about the effects of missed mortgage payments, short sales, foreclosure and bankruptcy on the owner’s FICO score. The post refers to a chart on the FICO blog that details how these events affect credit scores and how long it takes to recover from each one.

This is required reading for anyone weighing their options among foreclosure/short sale/bankruptcy.

Most interesting to me was that your credit suffers more if you have a deficiency balance after a short sale than if there is no deficiency balance. I find that deficiencies are NOT forgiven in most short sales, so the credit effect of a short sale with no release is the same as a foreclosure!

I review the credit of many clients and most of them are around 520 to 600 after they have missed three mortgage payments (much lower than indicated in the chart).

As far as recovery of credit after goes, one can get a new FHA mortgage with a 620 FICO score (after the required wait), and that’s not too much of a leap from even the lowest levels listed.






Getting a mortgage after bk, short sale or foreclosure

It is possible to get a new mortgage after a short sale, bankruptcy or foreclosure, but it takes awhile.

The chart above tells how long it takes, after each of these events occurs, to get a new mortgage.

The first column labeled FNMA is a standard Fannie Mae, conventional mortgage, and this generally requires a 10% downpayment. The second column labeled FNMA 20% is a mortgage with 20% down. The third column is an FHA mortgage, which requires only 3.5% down, and is the current favorite these days with first-time buyers, because it requires credit of about 610 FICO and is otherwise easier to qualify for compared to conventional financing.

Most clients get FHA mortgages after a bankruptcy, which is only a 2 year wait.

The waiting periods are one thing to consider when deciding how to handle a underwater real estate and whether a strategic default is worth it or not.

Monster in the closet: Collection agency or deficiency judgment?

When it comes to foreclosures and strategic default,  clients are very afraid of deficiency judgments. Deficiency judgments are like the monster in the closet — unseen, but scary as hell. Homeowners in or near foreclosure are terrified of these things, but there is no reason to be afraid because in the cold light of day deficiency judgments shouldn’t be feared  since they are so rare. I have yet to talk with a client against whom a deficiency judgment was entered in Illinois.

In reality, it may be that collection agencies are a much bigger threat to those thinking about strategic default or in foreclosure now. Channel  5 reported on this last summer, but it seems to be increasing since then.

I have had two cases recently in which lenders assigned their foreclosed mortgages to collection agencies. The collection agency starts calling and sending letters and finally files a lawsuit for “Breach of Contract” against the owner. A breach of contract case can be filed because the owner signed a promissory note at closing. The liability on the note survives the foreclosure. The statute of limitations on cases like these is a hefty 10 years.

Mostly this is happening on second mortgages, not first mortgages, but it is still possible on a first mortgage. Citibank seems to be very active in sending its delinquent second mortgages to collection.

Case 1: In the first case, the client had been foreclosed 5 years ago.  Then, suddenly the client started getting letters and calls from a collection agency. This agency specializes in “seriously delinquent and defaulted loan portfolios.”  I don’t know for sure, but most likely they agree to a contingent fee based on whatever they can collect from the foreclosed loans a lender assigns to them.  Most likely the client will have to put up with a series of calls and letters and then a lawsuit will be filed. When a judgment is entered the client will have to file bankruptcy to get rid of the judgment.

Case 2: The client owns a Chicago condo that is currently in foreclosure and, before the foreclosure was even completed, Citibank filed a breach of contract case against the owner based on the client signing the note for a second mortgage.  When this happens a whole separate lawsuit is filed. This is not part of the foreclosure case and it is not a deficiency judgment. A local law firm that is a well-known debt collector filed the case. The client will have no alternative except to file bankruptcy after the judgment is entered.

(Update 10/20/10: Wells Fargo is also filing collection actions on second mortgages. A McHenry County client was served with a $40,000.00 breach of contract case.)

I think that it’s very likely that lenders will continue to hand over their foreclosed loans to collection agencies in the hope of at least getting something back on delinquent loans. This is another reason to carefully weigh whether a strategic default is worth the cost, since you will have to look over your shoulder for 10 years until the statute of limitations expires. Ultimately, a chapter 7 bankruptcy will be the only way to eliminate the collection agency from the picture.

The best way to protect inheritances

If you leave money outright to your children or heirs, the inheritance can be lost by your heirs in several ways: Divorce, creditors or bankruptcy are the main culprits.

There’s a simple way to avoid this and to protect the heir from him or herself.

In the trusts that I prepare, most clients choose to leave the inheritance in a “flexible protective trust.” This is  fancy name for a “spendthrift trust.” Usually, a flexible protective trust leaves it up to the child/heir to decide whether to withdraw the funds ( if the coast is clear) or leave the funds in the trust where the inheritance is protected.

Inherited money that the child leaves in a flexible protective trust cannot be taken in the child’s divorce, cannot be attached by child’s creditor and it is exempt is bankruptcy, meaning the child will not lose the inherited money if he files bankruptcy.

A recent bankruptcy court case, In re Lunkes,  illustrates that there is really no reason to leave an inheritance directly to a child or heir. It is always better to play it safe and at least set up a flexible protective trust and let the heir decide if it should be protected within the trust or not.

In the Lunkes case, a parent died and left money to the children, but the funds were left outright, not in a flexible protective trust. One of the kids filed a chapter 7 bankruptcy and claimed that the inheritance was exempt, and that he should be able to keep the inheritance. The kid’s argument was that, hey… the funds are still being administered in the trust (there was a lot of real estate that now takes an eternity to liquidate) so since I don’t have the inheritance yet, it can’t be taken away in the bankruptcy. The court said, sorry, the funds were left outright to the child, not in a flexible protective trust, so the inheritance goes to the bankruptcy trustee. This could have easily been avoided by using a flexible protective trust. Inherited money left in a flexible protective trust is exempt in bankruptcy (meaning the child/heir gets to keep the inheritance).

There are only three rules to for setting up a flexible protective trust:

1. The funds have to be held in trust, not left outright.
2. The child/heir cannot be the trustee.
3. The trust has to contain a spendthrift clause. Most trusts contain these.  An Illinois spendthrift clause reads like this:  “No interest under this instrument shall be assignable by any beneficiary, or be subject to the claims of his or her creditors, including claims for alimony or separate maintenance. The preceding sentence shall not be construed as restricting in any way the exercise of any right of withdrawal or power of appointment or the ability of any beneficiary to release his or her interest.”

The truth is that very few heirs are going to actually leave the inherited money in the trust. But it’s best to give them the option, right?  I don’t charge any extra fees for drafting a flexible protective trust provision. It’s very easy to do. It’s my default, go-to way to distribute to the heirs in 99% of trusts that I draft.

So, do your heirs a favor and at least give them the option of protecting their inheritance in a flexible protective trust.

Can student loans be discharged in bankruptcy?

Just this week, I’ve talked with three prospective clients who want to try to discharge student loans in bankruptcy.

I don’t like delivering bad news, but it’s close to impossible to get rid of student loans by filing a bankruptcy.

Before 2005, private student loans were dischargeable in bankruptcy. Since then, very few federal, state or private student loans were able to be cleared with a bankruptcy.

Here’s an example of how hard it is to discharge a student loan: In 2008, there were 72,000 student loan borrowers in bankruptcy. A whopping 29 of those had their student loans discharged. Those are not great odds.

The bankruptcy courts require you to show “undue hardship” to get rid of a student loan. This means that a separate motion has to be brought before the judge and you have to show you made an effort to pay the loan and that continuing to pay it would mean that you couldn’t afford basic living expenses.

Nationally, the amount of student loan debt now surpasses credit card debt!

There is a proposed law in Congress that would allow private student loans to be discharged in bankruptcy. Here’s an interesting discussion of that proposal. I would not hold my breath waiting for this to pass.

The only remedy available for those in trouble on student loans is to file a chapter 13 bankruptcy. This will consolidate the loans and will stop interest and penalties. To do this, you need an income. Beyond income, you need what is called discretionary income, that is some money left to pay creditors after your basic expenses, to file a chapter 13.

For now, if you take out a student loan you are pretty much stuck with it, unless you qualify to file a chapter 13 bankruptcy.

Foreclosure and deficiency judgments

One sign of a terrible economy,  to me, is how many times per week I discuss with a client how foreclosure works. Clients are worried about foreclosure, but they are especially fearful that the foreclosing lender will obtaining a deficiency judgment against them.  If you check any real estate advice website like Trulia, there are many, many people asking about the effects of foreclosure and how deficiency judgments work. (Update: Illinois courts are now entering deficiency judgments routinely on first mortgages. This post discusses the increase in deficiency judgments.)  Here’s how  deficiency judgments work in Illinois:

Are deficiency judgments allowed in Illinois?


What is a deficiency judgment?

If a property is foreclosed, it is sold at a sheriff’s sale. If the property owner owed $100,000 on his mortgage when he was foreclosed, and the property is sold at the sheriff’s sale for $80,000, then the lender can get a deficiency judgment for $20,000.00. This means a court order is entered saying that the owner owes the lender $20,000.00. (As discussed below, obtaining a judgment and actually collecting the judgment are two different things.)

When is a deficiency judgment entered?

Usually, the deficiency judgment is requested in the foreclosure complaint. The judgment is entered at the foreclosure sale confirmation hearing after the sheriff’s  sale at the end of the foreclosure.

Can the lender get a deficiency judgment if I was served by publication in the foreclosure?

No. You have to be personally served by the sheriff or process server. The lender cannot get a deficiency judgment if you were served by publication (as many homeowners are). Another way to get a deficiency judgment entered against you is if you file an “appearance” in the foreclosure case.

What are the chances of the lender coming after me for a deficiency judgment?

If the property was your primary residence, the chances are slim (my  estimate, totally unsupported by facts or statistics, is 5%) that a deficiency judgment will be entered. Very few deficiency judgments are being entered in Cook County according to attorneys I know who practice in the foreclosure area. If the foreclosed property was investment property ,or the mortgage was held by a small local lender, then the chances of a deficiency judgment increase greatly.

What can the lender take from me if they get a deficiency judgment?

A deficiency judgment is like any other judgment that is entered for an unpaid medical bill or unpaid credit card. After the judgment is entered,  the judgment holder serves you with a “citation to discover assets” and you have to go to court and produce a copy of your tax return and a list of your assets.  They use this information to garnish your wages or to take any non-exempt assets from you to pay the judgment.

What assets are exempt from collection after a deficiency judgment?

These items are exempt from judgment:  Life insurance, 401ks, IRAs, $15,000 in equity in a house ($30,000 for a married couple). If your house is titled as Tenancy by the Entirety (married couples and primary residence only) and provided the judgment is only against one, not both, of a married couple, then the entire house would be exempt.  Since we are talking about a foreclosure, it is unlikely that the judgment debtor will even have a house to worry about.  85% of wages are exempt from garnishment too.

How can I get rid of a deficiency judgment?

The only way to get rid of a deficiency judgment is to file a chapter 7 or chapter 13 bankruptcy. A chapter 7 wipes it out altogether. In a chapter 13, it is partially repaid.

Can’t I just give my other assets to my relative to hold for me?

You can gift assets to a relative. But any transfer to a relative or anyone else that is not “for value” can be undone as a fraudulent transfer.  Transfers to relatives are especially suspect. In addition, there is the risk that your relative will not repay you or may get divorced or file his or her own bankruptcy.

If my lender does not ask for a deficiency judgment in the foreclosure, can my lender file suit against me for a deficiency judgment after the foreclosure?

Yes, Illinois law specifically allows a lender to file suit against a borrower after a foreclosure as a separate collection lawsuit.  With first mortgages, this is very rare and most likely will not happen, unless the lender is a small bank or the property was not your primary residence. Some lenders holding foreclosed second mortgages (especially Citibank and Wells Fargo) now hand over the loans to collection agencies to file a separate lawsuit against the homeowner for breach of contract. Read more about that here.

Can my lender file suit against me for a deficiency judgment after I sell my house in a short sale?

Yes. The best practice is to negotiate a “no deficiency”  provision in your short sale.  If you can’t  get that from the lender, then you will have to wait it out and hope that the lender does not ask for a deficiency judgment in the future. Most likely they will not pursue the borrower, but you never know for sure.

If I deed my property back to my lender in a “deed in lieu of foreclosure” can my lender get a deficiency judgment against me later?

No. The lender cannot get a deficiency judgment. Unfortunately,  a deed in lieu of foreclosure is kind of the equivalent of a unicorn; one doesn’t exactly show up in your back yard every day.

How long is a deficiency judgment last?

A judgment in Illinois is valid for 7 years from the date it is entered.

I’ve heard that in a foreclosure my lender can 1099 me for “forgiveness of debt.” Can they 1099 me and get a deficiency judgment against me too?

Usually, if a lender 1099s you, the lender will not seek a deficiency judgment. This is just how lenders operate, not the law.  By law, the lender must issue a 1099 after a foreclosure or short sale. The issuance of the 1099 does not mean that the debt is erased by the lender. It just means that the forgiven debt is taxable to you.

If the lender 1099s you and later seeks a deficiency judgment, the lender would have to issue a revised 1099, that’s all. So the issuance of a 1099 does not bar a deficiency judgment. Technically, the lender can 1099 you AND file for a deficiency judgment. You have to keep in mind that the lender could still get a deficiency judgment after a 1099 is issued. The only sure elimination of both the 1099 and deficiency judgment is to file bankruptcy before the 1099 is issued.

There are several cases that deal with this topic: In re Zaika, a PA bankruptcy court case  and AmTrust v. Fossett in AZ are a couple that summarize the law.

If the foreclosed property was your primary residence,then you have no income from the 1099 by law under the Mortgage Debt Forgiveness Act. If the property was not your primary residence, then you will have phantom income from the 1099 to deal with.