Short sales can be a good alternative to foreclosure, for both you and your lender.
Short sales can be an excellent alternative to foreclosure, for both you and your lender. While there can be many benefits for the seller in a short sale, there are some specific challenges that any seller should be aware of. Getting a clearer picture of what the benefits of a short sale to the seller are may help you make a critical decision about your financial circumstances.
Do you know what a short sale is?
The first consideration you'll need to address is whether you know what a short sale actually is. Formally, a short sale is a real estate transaction in which the sales price for the property is (knowingly) insufficient to pay the debt(s) and obligations encumbering the property along with the costs of sale, and the seller is unable to pay the difference. In other words, a short sale is when you sell your home (after it has been placed in formal pre-foreclosure status) for less than the total arrears and what you owe on the mortgage as an alternative to losing the house to foreclosure proceedings.
This can happen for a number of reasons but the most common one is that your home value has dropped significantly while your mortgage payments haven't.
Your lender must agree to a short sale and approve any offers on your home. Essentially, the lender is agreeing to take a loss in order to benefit from the eventual proceeds of the sale and to avoid the lengthy and costly process of formal foreclosure.
Understand the terms of all deficiencies
It is key for the seller (you) to understand that every short sale is dependent upon the lender consenting to the transaction and agreeing to release all of its security interest in exchange for less than what is owed. In some cases, the lender's approval of a short sale does not necessarily mean the lender relieves the seller of all liability for repayment of the entire debt. It is possible that you can sell your home in a successful short sale and still owe the unpaid difference, plus interest and penalties, to the lender (the deficiency). The lender may then seek a deficiency judgment against your for this difference. (If a court issues that judgment, it could be in effect for up to 20 years if not paid sooner.)
This is one of the most fundamental issues any seller must address in considering whether to sell property as a short sale.
You should know whether you still owe your lender money (a deficiency) after the short sale. You should know this before you pursue any short sale and especially before you close the short sale of your home.
Even if a lender agrees to a short sale, the lender and any junior lien holders may not agree to forgive the debt entirely and may require you to pay the difference as a personal obligation.
There are many types of liens and other obligations that are secured by real estate, including:
- Purchase loans
- Refinance loans
- Home equity lines of credit
- Contractor liens
- IRS tax liens
- Liens for unpaid child support
The type of debt and type of property will determine what remedies a lender may have if you fail to make the required payments. The lender's policies regarding forgiveness of debt, the tax consequences, your overall current or potential future financial strength, the lender's willingness and procedure for processing a short sale request, and the number and nature of other recorded encumbrances (second mortgages for example) on the property are some of the many factors a seller should consider in deciding whether to pursue a short sale.
If, even after a short sale, you will be faced with these outstanding personal obligations, it could result in a subsequent collection action against you. For example, a lender may accept the short sale purchase price to release the lien on the property but still require you to pay the full amount of the original debt. Be certain of all of the terms of any short sale before making a decision. All agreements between you and the lender really should be in writing and you would be well advised to seek legal counsel.
One big advantage, avoiding foreclosure
The biggest incentive for a seller in pursuing a short sale option is that you can possibly avoid all the devastating effects of a foreclosure. A foreclosure can stay on your credit record, weighing it down with very negative results, for many years. If you can get your lender to agree to a short sale and successfully negotiate one, you will be in a better position to repair your damaged credit from the circumstances that led to your needing to short sell.
That's not to say that you won't experience some impact on your credit score. A short sale may appear on your credit report as pre-foreclosure redemption, paid in full for less than full balance or other similar term. In most cases, a short sale will have a far less damaging impact on your credit than a foreclosure or deed in lieu of foreclosure (or any other outcome).
Some lenders may tell you that they will not consider you as a short sale candidate unless you are behind on payments. Do not intentionally withhold mortgage payments, solely for short sale consideration, without first getting some sound advice (preferably from competent legal counsel.)
More flexibility and security
Another way in which a short sale can benefit you as a seller is that during the process of setting up, pursuing and completing the short sale, you won't have to move out of your home right away. In fact, you'll be able to stay in your home until the close of the escrow. In many cases involving formal foreclosure, residents are evicted (or asked to vacate the premises) prior to the final stages of foreclosure.
In the process of a short sale, you may also find some additional flexibility and financial relief. In most cases, you will not be required to make your mortgage payments while your home is undergoing a short sale. This can give you several weeks or even months of relief as you look for alternative housing and save money.
Depending on your mortgage lender and the circumstances of your financial distress leading to the short sale, you may be eligible for relocation assistance. You may qualify as part of the federal Home Affordable Modification Program (HAMP) and one of its programs referred to as the Home Affordable Foreclosure Alternatives programs (HAFA). Under HAFA, you may be eligible for up to $10,000 in relocation funds in conjunction with your pursuit of a short sale.
Beware of tax consequences
As a seller considering a short sale, understand that a short sale may result in a higher tax debt. A short sale in which the debt is forgiven is considered a relief of debt and may be treated as income for tax purposes. The Mortgage Forgiveness Debt Relief Act of 2007 created a limited exemption to allow homeowners to pay no taxes on debt forgiveness; however, only cancelled debt used to buy, build or improve a principal residence or refinance debt incurred for those purposes qualifies for this tax exemption.
If you decide to pursue a short sale, be patient with the process. Some short sales can take several months to arrange and complete. Remember, your lender has to give final approval to all offers and all transactions and there can e many reasons why this process can take extended time.
You should also understand there may be a waiting period before you can buy another home. Your ability to qualify for a loan to purchase another home after a short sale will likely be impacted because of the impact on your credit score. It may be some time before a lender will loan you the money to purchase another home.
The procedures leading up to a short sale can be very complex. The paperwork to properly close a short sale is even more so. Experienced legal counsel can help you determine whether a short sale is the best option for your specific situation. A good legal adviser can steer you through the short sale process. A short sale is a complex transaction and the consequences of improperly pursuing and completing one can be as bad for your financial future as a messy foreclosure.
Trying to avoid foreclosure can be very stressful. However, it's important to understand short sale benefits for the seller. RealtyNow can help you find a local real estate agent who specializes in short sale listings.
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