When confronting a home that is “under-water”, it is important to understand how bankruptcy can impact the situation.  Sometimes bankruptcy and a short sale work together for the benefit of the seller/debtor and other times it makes sense to wait to filebankruptcy.

Benefits of Chapter 7 Bankruptcy and a Short-Sale:

Lien Strip:bankruptcy and a short sale

One of the best reasons to file a bankruptcy prior to a short-sale, is to take advantage of the debtor’s ability to strip judicial liens off of title. Following a motion and order to strip the lien, the property may be sold free and clear of these unsecured junior liens. This sale may now to be negotiated with just secured lien-holders, reducing the negative equity in the property. A lien strip must be done while the debtor owns the property and is in an active bankruptcy.

Automatic Stay:

After a bankruptcy is filed the automatic stay goes into effect, stopping any attempt to sell or fore-close on a property. This restriction is not removed until the case is closed or a relief from this stay is requested and granted by the Court. This can create additional time to negotiate the short-sale, but should only be used when it is in your best interest.

Issues with Chapter 7 Bankruptcy and a Short-Sale:


Once a bankruptcy is filed, the property no longer belongs to the debtor but rather the Chapter 7 Trustee. In order to move ahead with a sale, while the bankruptcy is still active, you will need to get permission from the Trustee. They may be willing to abandon the property since it has no value or they may want to negotiate with you instead.

Unexpected Costs:

Any costs related to the short-sale incurred after the seller has filed for bankruptcy will not be forgiven. This may include liability for any deficiency judgment created through the sale.

Ability to File:

In order to qualify for bankruptcy, it may be necessary for the seller to file before the short-sale rather than afterwards.  Please consult a bankruptcy attorney for a free consultation to understand if this applies to your situation.