Does getting past the means test on Bankruptcy Form 22A get you into a chapter 7 bankruptcy without further consideration?  In most cases the answer is yes, but in some cases the bankruptcy trustee may challenge the chapter 7 petition (and then seek to have the case converted to chapter 13 or dismissed) if Schedule J still shows net income that may be sufficient to fund a chapter 13 plan.

Practice tip! Before you file your chapter 7 petition take a close look at the net income difference between schedule I and J and pay particular attention to the expenses on schedule J. If there is net income that could fund a chapter 13 payment, or the expenses could be challenged and reduced resulting in net income, you could end up with the trustee arguing for dismissal or conversion to chapter 13.

Passing the means test leads to the conclusion that there is no presumption of abuse under Bankruptcy Code Section 707(b)(2)(A).  The problem is that Form 22A allows you to (in fact tells you to) use standardized expenses.  It’s not unusual for expenses on Form 22A to differ from Schedule J (schedule J even says, right across the top, that they might be different).  Showing net income on Schedule J may lead a trustee to suggest that the chapter 7 petition is abusive.

Here’s the problem. The fact that you pass the means test may mean that there isn’t a presumption of abuse, but Bankruptcy Code Section 707(b) includes more than just the means test presumption. Section 707(b) says that dismissal or conversion can occur for any abuse, and Sec 707(b)(3)(A) and (B) says that abuse includes bad faith or that the totality of the circumstances of the debtor’s financial situation demonstrates abuse.

There are numerous bankruptcy court cases discussing this issue (see, for example, 2011 WL 5925527), but the “totality of the circumstances” analysis typically looks to the following:

1) whether a debtor had the likelihood of sufficient future income to fund a chapter 13 plan which would pay a substantial portion of unsecured claims;

2) whether a debtor’s petition was filed as a consequence of illness, disability, unemployment, or some calamity;

3) whether the schedules suggest the debtor obtained cash advances and consumer goods on credit exceeding his or her ability to repay them;

4) whether a debtor’s proposed family budget was excessive or extravagant;

5) whether a debtor’s statement of income and expenses misrepresented the debtor’s true financial condition; and

6) whether the debtor engaged in eve-of-bankruptcy purchases.

The trustee is likely to focus on the first point – that net income as shown on Schedule J could fund a chapter 13 plan payment and pay a substantial portion of unsecured claims.  That does not speak to any of the other factors, but the courts appear to put more emphasis on that factor than any other factor individually.

Note also that Section 707(b) used to look for “substantial abuse”, but under the BAPCPA amendments it was changed to just “abuse”.  Be careful of that distinction when looking at historical cases  – it is a much lower bar for the trustee to meet. A previous case finding that there was not “substantial abuse” could be decided much differently today.

Should I do a short sale, or just let the bank foreclose? We’re asked that question more times than we can count. What’s the answer? Well, I hate to sound like an attorney, but the answer is “it depends”. It depends on a variety of factors that are specific to each person’s situation. In other words, the right answer for one person is not the right answer for anyone else.

One of the more significant questions to consider is this: If I lose the home in either a short sale or a foreclosure, or if I declared bankruptcy, when will I be able to get financing to buy another home?

Declaring bankruptcy, short selling, foreclosure, deed in lieu … any of these will require you to wait a certain amount of time before you can get financing to purchase a home.

How long to have to wait depends largely on how you lost your prior home and whether you had to file bankruptcy. The result is dictated by the FannieMae loan underwriting guidelines. FannieMae really isn’t in the business of loaning people money to buy houses. It is, however, in the business of buying loans from banks so that the banks can turn around and loan more money to more people to buy houses. FannieMae sets forth very specific underwriting guidelines that nearly all lenders follow. Why do they follow them? Because if they don’t FannieMae won’t buy that loan from the bank.

Under the 2011 FannieMae Selling Guide, there are waiting periods that restrict when a person can obtain a new mortgage loan if that person previously lost a home in a short sale, deed in lieu of foreclosure or foreclosure. The waiting periods also vary depending on how much money the person is going to be putting down. The periods begin to run from the date an action is completed, discharged or dismissed (that is, they would begin to run on the date a short sale is complete, a bankruptcy discharge is obtained, etc.)

In summary, the waiting periods are as follows:

Deed in lieu or short sale - as little as two years (with a 20% down payment) and up to seven years in certain cases.

Chapter 7 or 11 bankruptcy – 4 years (2 years in certain extenuating circumstances)

Chapter 13 bankruptcy – 2 years from the date of discharge, or 4 years from the date a case is dismissed (2 years in certain extenuating circumstances)

Multiple bankruptcy filings – if you’ve filed bankruptcy more than once in the last 7 years, a 5 year waiting period is required (3 years in certain extenuating circumstances)

Foreclosure – 7 years from the date of the foreclosure sale (3 years in certain extenuating circumstances, and then at least 10% down payment is required and a purchase can only be of a principal residence)

What’s an “extenuating circumstance”?  FannieMae defines it as follows:  Extenuating circumstances are nonrecurring events that are beyond the borrower’s control that result in a sudden, significant, and prolonged reduction in income or a catastrophic increase in financial obligations.

Looking at the above, it appears that in many cases having a chapter 7 bankruptcy on your credit file is no worse than a deed in lieu or a short sale.  So why, then, doesn’t everyone faced with losing their home just do a chapter 7 bankruptcy and end the stress?  Well here’s the rub.  If you file chapter 7 bankruptcy (or even chapter 13 or 11), you have not automatically eliminated the possibility of a foreclosure.  You’ve eliminated your personal liability for the promissory note, but your name is still on title to the real property.  In order to get title back the lender is going to have to seek relief from stay in the bankruptcy proceeding and then continue with the foreclosure.  In other words, you could end up with both a bankruptcy and a foreclosure on your credit file, in which case I suspect FannieMae would go with the longer foreclosure waiting periods.

Even if you go through bankruptcy, it often still makes sense to work with the mortgage lender on either a deed in lieu of foreclosure or short sale.

What to do?  Understand that bankruptcy and either a deed in lieu or a short sale are not mutually exclusive.  If you do one, it doesn’t mean that you cannot do the other.  It is not at all uncommon to proceed with a bankruptcy and at the same time short sell a home.  The most important thing to do is consult with legal counsel that knows something both about bankruptcy and real estate / foreclosures so that you can be properly advised on all of your alternatives and the consequences of any particular decision.

The New York Times recently published an interesting article on the growing number of people that walk away from underwater homes. (When I say “underwater” I mean a home with loans that exceed value.) You can find the article here, but the gist of it is that an increasing number of people who have the financial capacity to continue paying their mortgages are abandoning devalued homes anyway.

The article (and the people interviewed in it) seem to be missing one crucial point. It’s not as easy as just letting the bank foreclose on the property and taking the hit on your credit. Home loans often have two documents underlying them. One is the promissory note that is the homeowners personal promise to pay the debt. The other is a security instrument (often a deed of trust) that gives the bank security for the promissory note. If the homeowner doesn’t pay on the note the security instrument gives the bank the right to foreclose. The result of the foreclosure is often an eventual sale of the property and application of the proceeds toward the promissory note debt.

Here’s the part that the article misses. The bank is still entitled to full payment of the debt shown on the promissory note. If the bank gets less than the full amount upon the sale of the property the bank can then proceed to sue for the deficiency.

In some states (such as Washington), if the bank uses a non-judicial foreclosure alternative (resulting in a trustee’s sale of the property) then the bank is not allowed to get a deficiency judgment. However, the bank is not required to use the non-judicial alternative and can instead elect to judicially foreclose upon the security and then get its deficiency judgment.

If you have the capacity to keep paying but decide to walk away because of the loss in value, what makes you think that the bank isn’t going to try to get the deficiency judgment against you?

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