Last updated on December 8, 2015.
You’ve fallen behind on your mortgage payments. Worse, your home is now underwater – it’s worth less than you owe. You want to save your credit score, get out of your mortgage, and avoid foreclosure. Is a short sale the answer you’re looking for?
What Is A Short Sale?
A short sale is when you sell your home for less than the amount you owe on it and the lender accepts that amount as payment for the mortgage. It’s a way to get out of the home and away from your mortgage without going through the foreclosure process. A short sale can be a good option if you owe more than your home is worth, because you don’t want to pay more than the value of the house over the course of your mortgage loan.
How Does A Short Sale Work?
A short sale works much like a sale under any other circumstances, with a couple of key differences. Most importantly, you’ll need the approval of your lender and anyone else who has a lien – a legal right to the property as security for a debt – against your home. If you have just the original mortgage, you only need the approval of that lender. If you have a second mortgage or a home equity loan, you’ll need approval from those lenders as well. This approval is required because the lenders are accepting less than the full repayment of the loan and giving up their liens, so they want to have a say in the process. Lenders will typically approve short sales when the home is worth less than what you owe and selling it through foreclosure won’t cover the cost of the foreclosure process to the bank.
How Long Does A Short Sale Take?
A short sale takes time – time to find a buyer and then up to several months to get approval from your bank. If you find the right buyer quickly, you may be through with the whole process in just a couple of months. If you have trouble finding a buyer, if the buyer is slow to work with your lender, or if the lender is slow to review the offer, you may need more than a year from listing to closing. Meanwhile, you’ll need to continue to pay your mortgage or the bank may start foreclosure proceedings. In other words, the timing varies widely. If you’re considering this option, you should ask an experienced realtor in your area how long they expect it to take to find a buyer based on the location and condition of your home.
Short Sale Deficiency
You might have heard that the bank takes the proceeds of the sale and you get to walk away. In twelve states, that’s precisely the case. In those states, once your lender approves a short sale and you sell the property, you’re free. In the other thirty-eight states, you may still be liable for the “deficiency” – the portion of the loan not repaid by the short sale. Your lender may require you to sign an unsecured loan for the deficiency as a condition of approval for the sale or may choose to sue you and get a deficiency judgment instead.
Will you have to pay a short sale deficiency? First, you should determine whether you live in a non-recourse state. If you do, a short sale will terminate both lien and debt. Once the short sale is complete, you’re free from the debt. If you live in a recourse state, you’ll probably still be liable for the deficiency after the short sale. However, that debt is unsecured and can be discharged if you file for bankruptcy, unlike a mortgage. You can find a list of recourse and non-recourse states here. California is an example of a non-recourse state where you won’t be liable for the deficiency. California law also prohibits lenders from making you sign a promissory note for that amount as a condition of approval for the sale.
Short Sale Tax Implications
If you live in a non-recourse state, a short sale may have serious tax implications. For tax purposes, you “earn” the amount of the loan that the bank forgives. The amount of the deficiency will be counted as income and you’ll have to pay taxes on it. If you’re on the line between tax brackets, that income may put you over the edge to the next higher bracket. However, there are important exceptions to this type of income and you should consult with your tax professional to make sure these exceptions apply to you and that you do not end up paying this tax.
How Does A Short Sale Affect Your Credit?
Short sales are often touted as a credit-friendly way to deal with mortgage default. However, a short sale can affect your credit by lowering it up to 200 points. The higher your score before the sale, the bigger impact it will have. If your credit is already low, it won’t make as much of a difference. Like a foreclosure, a short sale will remain on your credit report for 7 years. However, remember that the impact of negative items on your report gets smaller over time, so you’ll be able to improve your score within a couple of years.
In some cases, your lender won’t even report the forgiven debt to the credit bureaus so you won’t a serious credit impact at all.
What Is The Difference Between Short Sale And Foreclosure?
As mentioned above, a short sale is one alternative to having the bank foreclose on your home. The main difference between short sale and foreclosure is who has control over the sale process. If you’re selling via a short sale, you get to find a buyer and set your terms. You do need approval from your lender, but you’re the one who starts and controls the process. The bank takes over in order to foreclose, meaning you’ll have to leave when your home goes to auction. Selling your own home also typically has a smaller impact on your credit; the lender may not even report the forgiven debt to the credit bureaus. The foreclosure process may allow you to stay in your home for several months, effectively rent free, while the bank works through the process. While you can also stay in your home until the completion of a short sale, that process can be disruptive. Be prepared to have prospective clients looking at the house and to host several open house events. You’ll also need to do more of the legwork yourself – you’ll need to find a realtor with short sale experience and prepare your house for showing. (Contact our office for a referral to a short sale expert).
Remember that these two options are not mutually exclusive. The fact that you are seeking a buyer for a short sale does not stop the bank from moving forward with a foreclosure or legal action. If you get an offer and the bank (and all other necessary parties) approves it before the foreclosure, then you can sell the house. If the bank gets through the foreclosure process before you bring a short sale purchaser of whom the bank approves, your efforts toward a short sale are wasted.
If your home does end up in foreclosure, you may want to consider filing a bankruptcy – that stops the foreclosure process.
Is A Short Sale Right For Me?
The answer depends on your circumstances. A short sale is a good option when your mortgage is underwater, you can’t or don’t want to continue making payments, and you can find a willing buyer. It may not be an option at all if you’re already in default.
Before you make a decision, you should consider all of your options. You may be able to offer the bank a deed-in-lieu of foreclosure. You may want to file for bankruptcy. You may want to allow the foreclosure process to proceed. If you’re struggling with your mortgage payments, do some research about what each option offers and requires. Each choice has different pros and cons – talk to one of our experienced attorneys to determine which is best for your unique situation.
M. Erik Clark is the Managing Partner of Borowitz & Clark, LLP, a leading consumer bankruptcy law firm with offices located throughout Southern California. Mr. Clark is Board Certified in Consumer Bankruptcy by the American Board of Certification and a member of the State Bar in California, New York, and Connecticut. View his full profile here.