If you are behind on your house payments and have decided you no longer wish to keep the house, you may be looking at your options including a short-sale, deed in lieu of foreclosure and bankruptcy. For this blog, we will specifically look at the short-sale. A short-sale occurs when real property (house, land, etc.) is sold to a third-party for an amount less than what is owed on the property. The short-sale is a way of transferring the property out of the homeowner’s name, but it does not necessarily eliminate the homeowner’s responsibility to pay the balance on the loan, known as the deficiency balance, after the sale. As a result, the homeowner may be making payments on a house he no longer owns. The short-sale will have a negative impact on the homeowners’ credit, since it will show the house was sold for an amount less than what was owed on the property, however, it will not be considered as negatively as the foreclosure.
It is best to illustrate what can occur in a short-sale with examples. The examples have been simplified and do not reflect any real estate broker fees or other real estate closing costs and fees. These examples also assume the house is the homeowners’ primary residence.
There is a $150,000 mortgage loan owed on the house, but in today’s market the house will only sell for $130,000. You may approach the mortgage company to determine if they would accept $130,000 short-sale for the property. In some cases, this may be acceptable to the mortgage company, since they would not be required to go through expensive foreclosure process. If there is only one mortgage loan, the short-sale can be a viable option. However, keep in mind that although the mortgage company agrees to the reduced amount so the house may be sold, it does not eliminate their right to pursue the homeowner for the deficiency balance on the loan, in this example $20,000.
$130,000 Offer on the Property
$150,000 Mortgage Lien
($ 20,000)Deficiency Balance
There is a first mortgage for $125,000, Home Equity Line of Credit (HELOC) for $30,000 and a Homeowners’ Association Lien of $1,000 or a total of $156,000 owed on the property. Consistent with Example One, the offer on the house is for $130,000. In order to proceed with the short-sale, the homeowners must get all three lienholders – first mortgage, HELOC and Homeowners’ Association – to agree to accept the $130,000 offer. Since the first mortgage will most likely insist on being paid in full, it is unlikely they will object to the $130,000 offer. On the other hand, the HELOC and Homeowners’ Association must both agree to share the remaining $5,000 and agree to release the liens on the property before the short-sale can occur. Also, just because the HELOC might agree to accept the short-sale, it does not preclude them from pursuing collection activities against the homeowners for the balance owed on the lien.
$130,000 Offer on the Property
$125,000 First Mortgage Lien
$ 30,000 HELOC Lien
$ 1,000 Homeowners’ Association Lien
As mentioned, it was assumed the house being sold in the two examples was the homeowners’ primary residence. As a result, there is no tax implication against the homeowners, since The Mortgage Forgiveness Debt Relief Act of 2007 allows the homeowners to exclude the deficiency balance, also known as “forgiven debt”, on their primary residence. On the other hand, if the property being sold is an investment property or any other property that was not the homeowners’ primary residence, the homeowners can be taxed on the deficiency balance or forgiven debt, since it is treated as income for tax purposes.
The short-sale is a viable option for many homeowners, however, it is important to be fully informed of the impact it may have on the homeowners’ financial position in advance of completing the sale. Request the mortgage company or mortgage companies sign a waiver stating they will not pursue a deficiency balance on the property. In many cases, the mortgage company will not agree to sign a waiver relinquishing their right to pursue collection activities, but it does not hurt to make a request. In addition, be prepared to make payments on the deficiency balance after the short-sale or consider filing bankruptcy to eliminate the deficiency balance and other debts.