Having trouble paying your mortgage? You may have heard that a short sale could be the answer to your problems. A short sale is a sale of a property where the proceeds of the sale are less than the balance owed on the mortgage covering the property. A short sale may be right for many people, but is it the best option for you? Consider the following before deciding on a short sale of your home.
Saving your credit score may be the most touted reason for choosing to short sale your home rather than letting it be sold at a foreclosure sale, but the reality is that a short sale is not much better for your credit score than a foreclosure.
According to myFICO, the consumer division of Fair Isaac (the company that invented the FICO credit score), short sales, foreclosures, and deeds-in-lieu of foreclosure are all "not paid as agreed" accounts and are considered the same for purposes of your FICO score.
You may be surprised to learn that a short sale does not automatically cancel your obligation to pay off the remaining debt on your mortgage. There are two parts to a typical home loan: a promissory note and a mortgage (or deed of trust). The promissory note consists of your promise to repay the lender. The mortgage (or deed of trust) creates a lien on your property. In other words, if you break your promise to repay, the lender has the right to have the property sold to pay off the loan.
So, when a lender approves a short sale, what is the lender agreeing to do? At the very least, the lender is agreeing to remove or release the lien on the property. A seller would have a near impossible task in selling a property without this lien release.
Is the lender also agreeing to cancel the seller's obligation to repay the loan in full? Not necessarily. Some lenders ask sellers to sign new, unsecured promissory notes before approving the short sale. Other lenders, without asking for new promissory notes, reserve their right to collect the deficiency—the remaining balance of the debt—within the fine print of their short sale approval documents (which you might not even see until the property sale is nearly due to close). After the short sale closes, the lenders start collections proceedings against the borrowers. Other lenders assign the debts to collection agencies, which then go after the sellers for repayment after the short sale closes. But in some states, first mortgages are non-recourse loans, meaning that you can't be sued for a mortgage deficiency after a short sale.
To be certain that you will not be on the hook to make any more mortgage payments after your short sale closes, ask your lender and get their answer in writing. If your lender refuses to give you a straight answer, contact an attorney to see if there are any state laws prohibiting your lender from collecting the deficiency.
If your lender forgives you for a deficiency after a short sale, you may owe taxes on the forgiven amount. That's because it's considered income by the IRS, upon which you may owe federal and state income tax. Under the federal Mortgage Forgiveness Debt Relief Act of 2007, you may be able to exclude from your income all or a portion of the amount of forgiven debt in a short sale, but only if:
Contact a tax professional or attorney in your area to find out whether you will owe any taxes as a result of your short sale.
Still can't decide if a short sale is right for you? Here's some more food for thought.
You have other options. Short sales can take a long time and a lot of work, with no guarantee that they will close in the end. Before embarking on a short sale, you may want to contact your lender about other foreclosure alternatives, such as refinancing your mortgage, modifying your loan, or negotiating the terms of a deed-in-lieu of foreclosure. Like short sales, each of these other options has its own set of drawbacks and benefits to consider before proceeding.
Is time on your side? Make sure you have enough time to sell your home. As mentioned above, short sales can take a long time, sometimes months, to close. Will you have enough time to market the property, find a buyer, and negotiate with your lender for approval before your house is foreclosed on? Short sale negotiations with your lender will not automatically stop that lender's foreclosure process.
You'll need approval before you close. Is there a second loan on your home? Is your mortgage covered by insurance? Do other creditors hold liens on your property? You most likely will need the approval of all parties with an interest in your property to close the short sale. This is bad news because the time and effort needed to close a short sale increases exponentially with each additional interested party. In this situation, you should identify all parties with an interest in your property and contact them early in the short sale process.