Even the Wealthy Have the Option of an Illinois Bankruptcy
The recent economic crisis - often dubbed the "Great Recession"
- definitely hasn't discriminated between the victims it has claimed.
It has significantly impacted the poor and well-off alike. This turbulent
economic period has even made honest debtors - debtors who just a few
short years ago would have never imagined missing any debt payments -
contemplate a remedy never before considered, namely bankruptcy. Ultimately,
bankruptcy under Chapter 7 or 13 is an option for anyone facing extreme financial difficulty - whether
their yearly salary is $20,000 or $1 million - and can often help those
who are considered "wealthy" just as much as anyone else.
Those debtors who have large yearly incomes should not let their pride
get in the way of their financial future. Bankruptcy is based upon your
ability to pay your debts and not by how much your paycheck is. It is
important to view bankruptcy solely as a financial decision and not be
embarrassed when you seek the protection bankruptcy can provide.
Underwater Mortgage: Short Sale or Bankruptcy
Recently, Illinois' wealthy have seen the advantages of bankruptcy,
often filed in response to their underwater mortgages - which is when
the mortgage on a home is greater than what the home is actually worth.
Unfortunately, many wealthy debtors with underwater mortgages fail to see
the benefits of filing for bankruptcy until it is too late. In some instances,
homeowners with negative equity in their homes, sometimes in the millions
of dollars, simply choose to walk away from the home or agree to a short
sale with the bank. Unfortunately for these debtors, Illinois is a recourse
state, which means that the bank can come after a debtor for the difference
between the amount of the outstanding mortgage and what they sold the
home for, often referred to as a deficiency judgment.
The situation would have been very different for the debtor, had he or
she originally considered bankruptcy. For example, if the debtor had filed
for bankruptcy in the first place it would have halted all collection
proceedings against the debtor, including foreclosure. This would give
the debtor time to determine his or her best options, which might include
a loan modification, loan repayment plan, liquidation or otherwise - all
without the possibility of a deficiency judgment.
In addition, if the debtor had specifically employed
Chapter 13 bankruptcy, not only would all proceedings be halted, but the debtor would have a
chance to save the family home by catching up on mortgage payments through
a payment plan approved by the court. These payment plans usually last
three to five years.
Moreover, under Chapter 13 bankruptcy a debtor with an underwater mortgage
would have the option to discharge a second mortgage or home equity loan.
The second mortgage holder is no longer considered a secured creditor,
because the property is not valuable enough to serve as the security interest
and the second mortgage is therefore unsecured. These second mortgages
can be stripped, and the bank will only receive their pro rata share of
the amount paid to all unsecured creditors.
Short Sale or Bankruptcy: Tax Implications
One of the other benefits of bankruptcy versus a bank approved short sale
is the tax implications of both. Generally when debt is forgiven, which
happens often when a short sale occurs, that amount can be considered
Conversely, debt discharged through bankruptcy is not taxable in the same
way, but the timing of what happened when can be very complicated and
even the slightest different detail can alter what is taxable or not.
It should be noted that the federal government passed the
Mortgage Forgiveness Debt Relief Act in 2007 which states that mortgage debt forgiven will not be taxed by
the IRS, but this Act currently expires in 2012.
For example, say a couple named Blake and Crystal purchased a home in Oak
Brook in 2006 for $1.2 million and took out a mortgage in the amount of
$800,000 at that time. Further imagine the same couple took out a home
equity loan in 2008 for home renovations in the amount of $100,000.
Today, Blake and Crystal have paid down their mortgage to a current outstanding
balance of $750,000, but due to the housing crash their home is now only
worth $500,000, leaving them dramatically underwater. If Blake and Crystal
were to agree to a short sale with their bank for $500,000, the bank could
still pursue Blake and Crystal for a deficiency judgment of $250,000 -
the difference between the sale price and the outstanding mortgage balance.
Even if the bank chose not to pursue this deficiency judgment, Blake and
Crystal may have tax implications on the $250,000 mortgage debt which
has been forgiven. Moreover, Blake and Crystal can also still be pursued
by the bank who gave them the home equity loan of $100,000.
If Blake and Crystal had considered bankruptcy, the outcome may have been
completely different. For instance, even if they chose liquidation under
Chapter 7, they still may lose their home, but the original mortgage holder
would not be able to seek a deficiency judgment against them and the debt
discharged would not be considered taxable. Also, if they elected to use
Chapter 13, Blake and Crystal may not only be able to save their home,
but the home equity loan for $100,000 may be "stripped" because
it is now unsecured.
As this article illustrates, bankruptcy law can be extremely complex. This
article barely scratches the surface of bankruptcy law as it pertains
to underwater mortgages - and as such this article should not be considered
legal advice - however, this article does demonstrate the need to contact
an experienced Illinois bankruptcy if your home is underwater and you
need help determining what the best option is for your situation.