Lien holder can rain on a short sale

Dear Bankruptcy Adviser,
I have three loans on my home. I filed for Chapter 7 bankruptcy and the first and second mortgages have been reaffirmed (meaning, she has agreed to be held legally liable for the loans after the bankruptcy is over) and I have been paying them on time. The third is a home equity loan, which I have stopped paying. All three loans were discharged in the bankruptcy. I can sell my home now and pay off the first and second mortgages. Because I am upside down, the third will not receive any proceeds from the sale.

I am considering doing a short sale to allow me to pay off the first two and get permission from the third to sell the property. I have someone who would like to purchase the home for fair market value. I am confused about the third mortgage loan. If I sold the home without getting the mortgage holder’s permission, could the mortgage holder still come after me even though the debt was discharged in the bankruptcy? Would I have to get the mortgage holder’s permission to sell no matter what? Would the third lender still have a lien on the home?

I am not sure how to proceed. Do you have any advice for me? Thank you!
— Mary

Dear Mary,
You might be facing either an impossible challenge or one that will cost you something. As you state, the third mortgage holder is completely unsecured. That means if that mortgage holder were to foreclose on your property, it would not receive any sale proceeds after you paid the first and second loans.

Unfortunately, to execute a short sale, you will need to get approval from all three lien holders. A lien is a legal claim against a piece of land for payment of some debt, obligation or duty. I will refer to the third mortgage holder as an “unsecured junior lien holder.” This means that the lender is behind in priority to both the first and second lien holders and no equity exists for its lien.

At this point, you are protected from the unsecured junior lien holder if you walk away from the house. You filed the Chapter 7 bankruptcy and that means that lender cannot sue you for failing to pay on that loan. The Chapter 7 eliminated your legal liability to pay.

However, eliminating your legal liability does not remove the lien from the property.

This gives the unsecured junior lien holder quite a bit of control over any short sale. And I have seen lenders act very unreasonably when clients are trying to execute one. Obviously, it is understandable that the lender will not be excited for you to sell the property and pay them nothing. The lender would be able to write off the loss after agreeing to a short sale, but that doesn’t mean the lender would want nothing.

In many cases, the unsecured junior lien holder will likely sign off on your short sale request for some percentage of the outstanding balance. For example, if you owe $40,000 on that mortgage loan and pay $5,000 of that amount, the lender would release the lien.

However, you must be very careful because some unsecured junior lien holders are requiring people to pay the entire balance in order for them to release the lien. You could pay an initial deposit of 10 percent of the outstanding balance but then sign a document agreeing to pay the remaining balance. You must diligently review any agreement before signing it.

I cannot estimate your likelihood of success, but as for most problems with loans and mortgages, money can usually resolve the issue. Maybe the new purchaser would be willing to settle with the unsecured junior lien holder who remains unpaid after the bankruptcy. You must be very careful before agreeing to any terms in order to complete the short sale.

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