Like any other professional, you as a realtor serve the whole client, not just a transaction. It is important that you know something about the nexus of divorce, bankruptcy, and real property law so you can have a frank discussion with your client should an issue arise or be forewarned of potential problems for you. This is not to say you will be dispensing legal advice! You just need to be aware of potential pitfalls for your clients and help them avoid them to the extent that you can. A client getting the outcome they want from a real estate transaction is a client who is satisfied with you and means positive reviews and referrals. You also should be aware of issues that could arise for you as the realtor for the buyer or seller dealing with bankruptcy, divorce, or both.
This article comes from the office of Bryn Mawr bankruptcy attorney David Offen. If any legal issues arise, be sure to counsel your client to seek legal advice from an experienced bankruptcy attorney in their jurisdiction.
Fact #1: Filing Bankruptcy Freezes All Creditors And Legal Action
If your client is selling their home and files for bankruptcy, know that a sale will not go forward. Also, if the client is getting divorced, the divorce is “stayed” pending the closure of the bankruptcy case.
If your client tells you they are selling due to financial hardship, you would be wise to ask if they are contemplating filing bankruptcy because you could put in a lot of work trying to sell the property only to have the sale frozen or worse, have the property surrendered in your client’s bankruptcy case or have the Trustee seize it.
Fact #2: If Your Client Is In An Active Bankruptcy Case, They Need Permission To Buy Or Sell Real Property
This happens most often in a Chapter 13 case, which is the type of bankruptcy in which the debtor pays monthly into a three- or five-year repayment plan in order to catch up with secured debt – like a mortgage – or pay off nondischargeable debt, such as sales tax or spousal or child support arrears.
It is not unusual for potential clients in an active Chapter 13 case to have to move for a new job. In this case, you may be able to stay on as the realtor handling the transaction for the seller if the seller petitions the court for permission and the Chapter 13 Trustee agrees to a valuation and sale price. This is not a sure thing, however. Many Trustees have realtors they work with frequently and would prefer to use them. If there is equity in the home over and above the amount your client can “exempt,” meaning, put out of reach of the seizure power of the Trustee, know that some of those funds will be seized and paid to creditors. This will not affect your fee, but again, your fee must be approved.
Fact #3: If Your Client Is Getting Divorced And The Real Property To Be Sold Is Jointly Owned, Valuation And Whether To Sell May Be Divorce Issues
It is not uncommon for a divorcing couple owning real property jointly to disagree over whether to sell or retain the property and if agreeing to sell, how much they are willing to sell it for.
You will have already asked your potential client whether they own the property individually or with someone else, and searched for judgments and other liens on the property. Now you need to have a frank discussion regarding whether both owners intend to sell. If there is a disagreement, your client’s lawyer and their ex’s lawyer must get involved.
More often, the owners disagree about valuation. Hopefully, your comps will bear the asking price you recommend, but it is up to both owners (and their lawyers) to agree.
Are you prepared to work under and through either of these situations?
Your answer to this question will likely depend upon how much rancor is between the two owners and the value of the home and your potential fee. Be sure, though, that if you take these clients on, you will face ongoing delays and disagreements. Potential buyers are often turned off by this or go on to another house.
Fact #4: Chapter 13 Bankruptcy Allows Your Client To “Strip Off” A Second Mortgage Or HELOC and Have It Discharged
If you are the seller’s agent and the seller is in financial problems, they should know that if they file Chapter 13 bankruptcy, they have the power to “strip off” a second mortgage or HELOC and have it discharged as unsecured. This is typically done in a weak home market.
Let’s say your potential client bought her home in an upmarket for $400,000. A few years later, she took out a HELOC for $25,000 to renovate the kitchen. A couple more years pass, and she still owes $360,000 on the initial mortgage and $18,000 on the HELOC.
You examine the home, run the comps, and conclude that the property is currently worth $352,000. Because the value of the property is less than what your client owes on the first mortgage, your client can file Chapter 13, strip off that HELOC as unsecured, and have it discharged, saving her $18,000 and eliminating that monthly payment.
This may mean your customer can now afford to stay in the home, and you lose the transaction. Although state legislation varies, advising your client that this alternative exists is definitely your ethical duty. Be sure to tell her to talk with a bankruptcy attorney. An initial session is frequently free of charge, so she has nothing to lose by investigating her bankruptcy alternatives.
Fact #5: If Your Client Can’t Afford To Stay In Their Home And Can’t Get Their Sale Price, They Can Simply Surrender The Property In Bankruptcy And Walk Away
Here’s a situation to watch out for and aim to avoid, as these potential clients will be enormous time-wasters for you.
You will have to run the comps and come up with a proposed sale price. If your client is underwater, which means he owes more on his mortgage than the property is currently worth, he may be hesitant to sell the property and still owe a deficiency balance after the sale.
That is an option if you have prior experience with short sales. Again, working with banks is not the most expedient process. Sometimes getting a lender's approval for a sale price takes so long that you lose your buyer. However, if the property can be sold as a short sale, the seller will be able to walk away from the transaction mortgage-free.
Whether you work with short sales or not, you should inform your potential client that the property could be sold as a short sale and that he can have the deficiency balance discharged as unsecured debt by legally "surrendering" the property in a Chapter 7 filing. A debtor can walk away from real property simply by checking a box on the bankruptcy forms.
Failing to warn a potential customer about the possibility of selling short or surrendering the property in bankruptcy could be an ethical infraction, one that a client might be able to sue you for if he is stuck with owing the deficiency balance after the sale of the property.
Fact #6: If Your Client Has Equity In The Property, The Chapter 7 Trustee May Seize And Sell It For The Benefit Of Their Creditors
In enacting federal bankruptcy laws, Congress did not intend for debtors to be stripped of all belongings. Rather, filing bankruptcy will provide debtors with a "fresh start."
When a person declares bankruptcy, everything they own, including real estate, becomes part of the "bankruptcy estate" under the control of the Court and the Trustee. To assist debtors in obtaining a fresh start, Congress enacted legislation providing for "exemptions" from the bankruptcy estate, ensuring that debtors emerge from bankruptcy with the property they require to live and move on.
Under 11 U.S.C. 522(d)(1), the current federal exemption for equity in real property is $25,150. Congress raises this amount on a regular basis to keep pace with the market and inflation.
Each state also has its own set of bankruptcy exemptions, and they vary by state and from federal exemptions. Your potential client will have spoken or should speak with a bankruptcy attorney to determine whether state or federal exemptions would best protect their property, both real and personal.
The states that allow a debtor to choose whether to use federal or state exemptions are Alaska, Arkansas, Connecticut, the District of Columbia, Hawaii, Kentucky, Massachusetts, Michigan, Minnesota, New Hampshire, New Jersey, New Mexico, New York, Oregon, Pennsylvania, Rhode Island, Texas, Vermont, Washington, and Wisconsin. If your client does not live in one of these states, they must use the state exemptions.
If your client has equity in excess of the exemption and still intends to file bankruptcy, you should advise them of the possibility that the Trustee will seize their property. Bear in mind that Trustees often add 5 or 10% to the amount of equity that is exempt to account for the costs of selling the property, so factor that into your calculation.
Equity and Divorce: here’s where staying married for just a bit longer benefits both parties and you! If they can agree to sell, agree on a valuation, and agree to retain you as their agent, know that if they file bankruptcy before they get divorced and before they sell, they get double the homestead exemption. For divorcing couples with more than $25,105 and less than $55,000 worth of equity in their home and using the federal homestead exemption, the timing of the filing, the sale, and the divorce are critical to whether they will make money or lose money.
The best you can do for your client(s) is to run the comps, provide them with a valuation, give them this information, and advise them to seek the counsel of an experienced bankruptcy attorney to determine whether the Trustee will seize their home rather than allowing them to sell it and realize a profit from the exempt equity. In cases involving the sale of real property, divorce, and bankruptcy, timing is everything!
Fact #7: Neither Bankruptcy Nor Divorce Absolutely Disqualifies Someone From Purchasing Real Property
In most cases, divorced people take a hit to their credit. Often their living expenses are greater than when they were part of a family household, and unless their income increases, that will put a strain on them financially and perhaps cause them to incur more debt.
Bankruptcy most definitely affects a debtor’s credit score. The fact of filing bankruptcy remains on a debtor’s credit report for up to ten years, however, a debtor can rehabilitate their credit by making all monthly payments in full and on time going forward and by minding their debt-to-income ratio. Interestingly, those debtors who receive a discharge of unsecured debt such as credit cards or medical bills often see their credit score improve a few months after their bankruptcy case closes due to the improved debt-to-income ratio.
Luckily, it is only a matter of guiding them to a mortgage professional who can help them qualify for a loan. A larger down payment, mortgage insurance, or a less-attractive interest rate might be required, however, neither divorce nor bankruptcy will keep a determined buyer from finding a way, and they can always refinance as their financial situation improves.
Hopefully, these seven facts will help both you and your potential clients!