Avoiding Foreclosure with a Short Sale
Why Selling Short Might Not be Right for Everyone
Oct 10, 2009
A short sale is a situation in which the lender agrees to allow the borrower to sell the house for an amount that falls short of the amount owed on the loan. In other words, a short sale means that the creditor has agreed to accept less than the amount owed. It sounds like a great way to avoid foreclosure, but a short sale may not be the answer in every case.
The Mortgage Lender Must Agree to the Short Sale
In order for the short sale to happen, the mortgage lender will have to agree to it in writing. Getting the mortgage lender to agree to the short sale may end up being a pretty big hurdle in one's quest to avoid foreclosure, depending upon the circumstances.
If the mortgage lender believes it will do better financially by going forward with foreclosure, it is unlikely to agree to the short sale. Unless the market value of the home has dropped significantly, it will not really be in the lender's best interest to agree to a short sale. After all, if the market value of the house is at or above the amount of the loan, the lender can recoup more of its money through foreclosure.
A Short Sale to Avoid Foreclosure May Cause Income Tax Problems
Except for certain conditions listed in the Mortgage Forgiveness Debt Relief Act of 2007, the debtor should be aware that the I.R.S. could consider debt forgiveness as income. Thus, the debtor who has made a successful short sale may end up having to pay income tax on the difference between the amount owed and the amount paid.
Nevertheless, forgiveness of indebtedness on one's qualified principle residence will not be considered income pursuant to the Act. Fortunately, this exemption does apply to many homeowners. Thus, unless one is seeking to avoid foreclosure on a vacation home or rental property, one may not encounter income tax problems with a short sale.
The Mortgage Lender May Sue the Borrower for the Difference
Unless the mortgaged property is located in a state that does not allow it, there is no guarantee that a mortgage lender who accepts a short sale will not bring a lawsuit against a borrower for the difference between the amount owed on the loan and the amount paid by the new purchaser.
If the debtor lives in a state that allows the mortgage lender to sue for the deficiency, he or she should try and persuade the lender to agree in writing not to do so. A foreclosure attorney can advise the debtor on the terms of the short sale agreement with the mortgage lender.
Houses with Second Mortgages May Not Qualify for Short Sale
If there is a second mortgage on the property, the mortgage lender holding the second mortgage must also agree to the short sale. A second mortgage is subordinate to the first mortgage, and the holder of a second mortgage may not be motivated to agree. After all, a short sale will leave a deficiency on the first mortgage. This means that the holder of a second mortgage will get nothing out of the deal at all.
Avoiding Foreclosure with a Short Sale will Affect One's Credit Score
Some people believe that avoiding foreclosure with a short sale will not be as damaging to their credit scores as having a foreclosure on their records. However, a short sale is, in effect, a redeemed pre-foreclosure. Thus, credit rating agencies may not make the distinction between foreclosure and a short sale for purposes of one's credit score.
Foreclosure Attorneys
Short sales work best in states that do not allow deficiency lawsuits and in situations in which there is no second mortgage on the property. Although a short sale may avoid foreclosure, it may not be right for everyone. A debtor seeking to avoid foreclosure through a short sale should consult with a foreclosure attorney to discuss all the potential ramifications.
Disclaimer: This article is in no way intended as legal advice. For help with specific legal issues, one should contact a licensed attorney in one's own jurisdiction.
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