Understanding the Short Sale Option to Foreclosure

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The current housing crisis, the most widespread in decades, is forcing unprecedented numbers of homeowners into foreclosure and often, considerable debt. For many, the prospect of foreclosure and debt seem so grim that they often turn to bankruptcy as a means of somehow stopping the pain. Unfortunately, in most cases, bankruptcy will not help.

Here in SW Florida, literally thousands of homes are in foreclosure or near foreclosure and the number grows every day.

The causes of this crisis are talked about in the press and on TV with blame being directed to the banks, the mortgage brokers, and the government. Regardless of who is to fault, the bottom line is houses are losing value every day and whatever equity there once was is now mostly gone. In fact, for many homeowners not only is the equity gone, but most likely their house is now worth less than what they owe! “We’re upside down,” is a statement we hear every day.

When this happens–when there is little or no equity in the house, (or the homeowner owes more than the house is worth), and the homeowner can no longer afford to keep up with existing mortgage payments, something clearly has to give.

If the homeowner wishes to keep the house then they must be prepared to handle a higher monthly payment either because they have refinanced or because they have accepted the bank’s terms for a workout.

Our experience tells us neither of these options make sense for a homeowner who may have already incurred substantial debt trying to keep up with mortgage payments, or who is already late by one, two, three, or more months.

In the first instance, it is next to impossible to refinance if the homeowner has bad credit or if the house has no residual value. And even if refinancing is possible, the homeowner must be prepared to pay considerably more for the new mortgage note.

Secondly, bank workouts almost never work for pretty much the same reason. Whatever deal the bank offers, you can be certain it will entail higher monthly payments. Few homeowners facing foreclosure have the resources to pay more, let alone pay what they currently owe!

This brings us to the short sale.

The short sale is far and away the best option a homeowner has when they are confronted with the likelihood that their house will be taken away from them by the bank and offered for sale at auction.

Before we talk about the advantages of a short sale and how it works, let’s first define what a short sale is.

A short sale is when homeowners agree to sell their house for less than what is owed. If the bank accepts the lower offer, the foreclosure proceeding is stopped and the homeowners are able to walk away from the house with no foreclosure recorded on their credit and much less liability for whatever deficiency (the difference between what is owed and what the bank gets) remains after the sale.**

Why is a short sale my best option?

When the homeowners cannot afford their mortgage payments and there are no realistic  workout plans, a short sale is the best option. The reasons are threefold:

First. A successful short sale stops the foreclosure.

Though the homeowner’s credit still suffers because of the many “lates” they have incurred, they will not have a foreclosure on their credit report. Even though they will have to leave the house, they do so on their own schedule. And, of course, once the foreclosure stops and the bank accepts the short sale offer, all the annoying and sometimes threatening calls stop. 

Second. A short sale reduces liability and in some cases, eliminates liability all together.

If a house is taken back by the bank in a foreclosure, the homeowner will be liable for all the money the bank stands to lose from the time the house went into foreclosure until such time as the house is sold. This can be a very large number and the bank will definitely pursue.

When a short sale is done however, the bank may pursue the homeowner for the deficiency but it is also quite possible that the bank will forego any further action to recover funds from the homeowner. The reasons for this vary from bank to bank but in essence what happens is the banks simply do not have the time nor resources to pursue debts that they know they stand little chance of ever collecting.

The banks will, however, notify the IRS of this ”foregiveness of debt” and the IRS will send the homeowner a  1099c form which states that the homeowner has a tax liability for whatever the deficiency was. If, for example, the deficiency was $50,000, this may be looked at as taxable income by the IRS.

Fortunately, this is a debt that can also be eliminated or greatly reduced. If the homeowner can show that at the time of foreclosure they were financially insolvent—that is, unable to pay their mortgage because of insufficient funds—the IRS will forgive this debt. Every homeowner who does a short sale should consult a tax specialist for advice on this.

Third. Stopping foreclosure stops the bleeding!

No more mortgage payments. No more annoying calls from bank creditors. Homeowners can start to rebuild their credit. They can rent a home they can afford, and once again, spend their time focusing on the good things in life!

How does a short sale work?

In order for the bank to accept a short sale offer, a number of important steps have to be followed.

A complete short sale package containing financial data and other documentation needs to be assembled and submitted to the bank. The house must then be listed with a broker who understands the short sale process. A reasonable offer must be obtained from a qualified buyer and then the bank must be convinced that the discounted offer is the best they are going to get. 

Doing all this requires close attention to detail, expertise in negotiating, creativity, and above all else, PATIENCE! Patience on the part of the homeowners who are anxious to get on with their lives. Patience on the part of the brokers who are eager to see the sale completed. And patience on the part of the future homeowners nervously waiting to see if they are going to have a house before school begins.

From start to finish the average length of time to complete a short sale is from 1 to 4 months! Banks are buried with short sale requests and even when they have a great offer on a house, they will often take months to even open the file.

In many instances, we are also able to negotiate with the bank to forgive the deficiency and accept payment from the house sale as full and final settlement. However, our ability to accomplish this is governed by the nature of the debt, the homeowner’s current financial status, and the willingness of the lender(s) to work with us. (Also, it should be noted that there are often tax consequences associated with a short sale and all homeowner’s should seek advice from qualified tax experts to determine what if any liability they will have when the file their annual tax return