If you are behind on your mortgage and know you can’t afford to pay the arrears, or, if foreclosure proceedings have already begun against you, you might be wondering if a short sale is a possibility.
Read on to find out what a short sale is, how it works, how it can stop foreclosure proceedings and the pros and cons of selling your home at short sale.
What is a Short Sale?
Real property is said to be subject to “short sale” when it is sold at some price that is less than the current owner owes on the mortgage. Often mortgage lenders will accept that lesser amount to save on the time and cost of a foreclosure proceeding.
How a Short Sale Proceeds
Usually, the first step is for a homeowner to start to struggle to make his or her mortgage payments on time and in full. In the current real estate market, it is likely that the subject property is “underwater,” meaning it would sell for less than what is owed on the mortgage.
At this point a homeowner has some options:
- If the homeowner has a steady income and feels he or she can afford to keep the home, negotiations with the lending institution to get a mortgage modification can commence;
- If the lending institution is uncooperative in reaching a loan modification, the homeowner can file a Chapter 13 bankruptcy petition and pay the mortgage arrears over a 3- or 5-year plan;
- If the homeowner cannot afford to keep the property, he or she can file a Chapter 7 bankruptcy petition and surrender it to the lender, and have personal liability for the mortgage balance discharged;
- The homeowner can contact a real estate agent and have the property listed at market value as a “short sale;”
- The homeowner can do nothing and just wait for the lender to take action – this gives the homeowner time to save funds to be able to move elsewhere, often several months or a year.
Real estate agents often work with short sale staff at lending institutions to arrange to list the property and sell it at market value, below what the homeowner owes. If a buyer makes an offer, it must be approved by the lending institution.
At that point, a savvy homeowner will negotiate over his or her rights before signing off on any sale. It is common for lending institutions to try to have the homeowner sign documents that impose continuing personal liability for the unpaid mortgage balance after the property is sold. That amount is called the “deficiency.” Homeowners should make sure that any sale documents they sign include a clause forgiving any deficiency balance on their mortgage account.
While a short sale can take many months and often a year or more to process, it appears that for most homeowners the impact on their credit score is much less negative than the impact of a foreclosure proceeding or a bankruptcy filing. Also, if the homeowner wants to borrow money in the future, lenders are more likely to look favorably upon them for having been proactive when they were in financial distress.
What is Foreclosure?
In judicial foreclosure states, the mortgage lender must file a foreclosure lawsuit in court in order to seize the property from the homeowner after the homeowner has failed to make a certain number of monthly payments. Foreclosure suits are filed whether the homeowner still resides in the property, or has abandoned the property. If the homeowners remain in the property, they are evicted, usually after the trustee’s or sheriff’s sale/public auction and when the new owner (often the lending institution) files an eviction proceeding. The procedure and timeline of a foreclosure action differ state-to-state.
Usually, a foreclosure proceeding happens more quickly than a short sale because the lender does not want the property sitting vacant, or to continue to be occupied by a borrower in default as they typically do not maintain the property and sometimes even damage the property purposefully while the foreclosure is pending. Of course, the mortgage lender will want to maximize return on the sale of the property once the foreclosure judgment is entered and so will move quickly once the initial foreclosure complaint is filed.
How a Short Sale Can Stop a Foreclosure Proceeding
There is no doubt that a homeowner who has allowed a foreclosure proceeding to conclude while doing nothing will take a hit to their credit score. Also, a foreclosure suit will remain on the credit report for seven years and it might take three or five years before a foreclosed homeowner will be lent mortgage funds again.
Considering this, even if a foreclosure proceeding has been filed by the lender, a defaulting homeowner should take the opportunity to contact a real estate agent and their lender and find out if a short sale is a viable alternative to allowing the foreclosure to proceed to a conclusion.
By opening negotiations with the lender and listing a property at a short sale, a homeowner can avoid significant negative credit consequences and transfer the property to a new owner in an orderly, responsible manner. It’s worth a shot, and if you don’t ask – you don’t get!
After Short Sale: What To Do?
What Do I do about the deficiency on the mortgage? Do I have to pay for that?
Yes, unless you negotiated with the mortgage lender to have the deficiency forgiven. If you did, that amount may be reported by the mortgage lender to the IRS as income.
If you did not have the deficiency forgiven, the mortgage lender can and likely will commence collection efforts against you. If that happens, again, Chapter 7 or Chapter 13 bankruptcy can get the deficiency discharged as unsecured debt.