Short Sale FAQ
What determines whether I will qualify for a short sale?
What happens to the “deficiency” or “short” amount?
What’s a deed in lieu of foreclosure? Can I just do that?
What determines whether I will qualify for a short sale?
There are a number of factors that determine whether you will qualify for a short sale which fall into two broad categories: your financial status and the value of your home as compared to the balance of your mortgage.
Until recently the only instance in which a lender would approve a short sale is when the a)the house was worth less than the mortgage and b) the owner had no ability to continue making the payments or make up the difference if the house was sold. However recent problems in the housing market…aka “the crash”…have loosened criteria for short sale approval. Short sales are being approved in all sorts of situations these days, but as a general rule of thumb if you can’t make your payments a short sale is possible.
What happens to the “deficiency” or “short” amount?
In both a foreclosure or short sale, lender has the option of “cancelling” the debt or pursuing a deficiency judgment.
Deficiency Judgment: is a judgment placed against a person giving the plaintiff legal recourse through which to pursue repayment of an unpaid debt. In the case of a foreclosure, this would be the difference between the mortgage balance and the amount for which the property sold on the courthouse steps. In the case of a short sale, this would be the difference between the sale amount and the mortgage balance. The amount of a short sale is generally higher than the amount at the courthouse steps, thereby lowering the amount of deficiency. In negotiating short sales, always try to get the bank to waive their right to a judgment.
Debt cancellation: is when the lender forgives the debt, however it has tax consequences (see note below regarding the 2007 Mortgage Forgiveness Debt Relief Act)*. In most situations the lender is required to issues at 1099-C to the homeowner, under which the amount of the cancelled debt is treated as taxable income. Same rules apply in regards to a foreclosure vs. a short sale, however the lender is very unlikely to cancel the debt in a foreclosure and very likely to issue a deficiency judgment instead. Given the choice, most folks would rather have the debt cancelled since then their further obligations in regards to the original loan are only the taxes on the deficiency rather than the entire amount of the deficiency.
There is one other option for short sales, and it is one that worries many people. The lender may offer to modify the promissory note by converting it to an unsecured debt. This should lessen the impact on the seller’s credit scores, but at the expense of still owing the money. It’s like a deficiency judgment with a structured payment plan. This is not the ideal outcome…we’re always shooting for debt cancellation…however this it 10 times better than a judgment. And remember, a judgment is the probable outcome of a foreclosure.
Keep in mind that you do not have to agree to the banks terms for the short sale. If they won’t cancel the debt, you do not have to sell. Since you’ll end up with a judgment otherwise, that’s probably not a wise move, but still it’s your choice.
*Under the 2007 Mortgage Forgiveness Debt Relief Act cancelled debts from qualified primary residences in 2007,2008, and 2009 can be excluded as income. For other years, if you can prove that you are insolvent at the time of short sale you may owe no tax. As always, talk with your accountant.
What’s a deed in lieu of foreclosure? Can I just do that?
A deed in lieu of foreclosure is just what a sounds like…the lender agrees to simply take your property and release you of any further obligation. In times where the market is rapidly appreciating and banks have low inventories of foreclosed properties this may be a viable option. However when the market is down and the banks have high inventories of homes they are not as likely to accept this option. It all comes down to whether or not they think they can sell your property and recoup their losses. Also keep in mind that the deed in lieu requires similar if not identical paperwork to the short sale and, if not accepted, you may loose valuable time in which you could have been looking for a buyer.
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