Q: I bought my home in 2005 for $230,000. Now it is worth approximately $100,000 less than what I paid for it and I just lost my job and am struggling to keep up with the mortgage payments. Should I short sale or just let the bank foreclose, or do a deed-in-lieu of foreclosure with the bank?
A: The first thing I have to put right out there and say, is I cannot give you legal or tax advice and I strongly encourage you to speak to a real estate attorney and CPA. That said, I get calls from Sellers all the time who are upside down on their homes and are struggling and wondering if they should “just walk away” and let it foreclose or consider a short sale.
What many people do not seem to understand is that letting a home foreclose or signing a deed-in-lieu of foreclosure with your lender does not necessarily release you from liability of paying off the mortgage just because you “gave it back”. In many cases, people who’ve been foreclosed upon, four years later, are surprised to get a letter from the bank stating that they owe a $100K deficiency judgment – the difference between what they owed and what the property sold for as a foreclosure. Yikes!!!
This is why, for many people, a short sale is the very best option. Let me be very clear. In the scenario you’ve given above, you have a $100,000 deficiency. If the homeowner walks away they are still liable for this deficiency amount, plus any late fees, attorneys fees, etc. Some people say “well then I’ll just file bankruptcy”. You need to speak to an attorney – in some areas you may or may not be able to include your residence in a bankruptcy and a short sale may be a much better option. There may also be tax implications in allowing a property to be foreclosed upon versus doing a short sale on a principal residence.
I recently had a client who was thinking about a short sale and had the bank also send him the documents about doing a deed-in-lieu of foreclosure because he wasn’t sure he wanted to go through the short sale process and thought the deed-in-lieu seemed like the easier thing to do. He didn’t believe me that if he “gave it back” so to speak, that he’d still be responsible for the balance owed on the mortgage. He started to read aloud from the letter he’d received from the lender about the deed-in-lieu option until he got to the fine print part about the fact the bank may retain the right to pursue the homeowner for the deficiency. Yikes. Don’t you think if the bank retains that right, they will eventually pursue you for that balance, years later? I wouldn’t want to have to worry about that big “maybe” if it was me.
Now, that said, even in a short sale scenario the bank may not, in every case, release the Seller from the deficiency owed. WHAT?! Why bother with a short sale then, you may be wondering. This is why its imperative to have a Realtor who is experienced in short sales who can make sure the correct language is in the approval letter to get your deficiency released. We always recommend that our clients to consult with a real estate attorney as sometimes the Realtor and attorney can work in tandem, and the attorney can get that deficiency forgiven forever. Also often certain banks will not pursue for a deficiency if the homeowner tried to do a short sale versus allowing a home to be foreclosed on or “strategically defaulting”. The bank ALWAYS prefers the homeowner try to short sale as it saves them thousands in processing and attorneys fees if they don’t have to foreclose.
Here are the reasons why it may be in your best interest to pursue a short sale:
1. Deficiency. The best way to short sale is under the government’s HAFA program – if you are eligible. Under HAFA, homeowners who qualify due to a legitimate hardship may have their deficiencies canceled completely by the bank and receive up to $3,000 in relocation assistance. If you don’t get into HAFA, generally banks are far likely to pursue a Borrower who does a short sale for the deficiency than one who simply walks away. For more on this, please call us so we can discuss the lender who holds your loan and their general policies.
2. You can buy a new home again sooner if you short sale, but Foreclosure follows you. If you let a home foreclose, you may not be able to purchase another primary or investment residence again. However, if you do a short sale, the banks look more favorably on this and you will be eligible to purchase a new primary residence with a Fannie Mae or non-Fannie Mae loan in only 2 years and interest rates should not be affected for you as your credit improves post-short sale. Homeowners will always have to disclose that they have had a foreclosure on any mortgage application and many job applications they may complete in the future. This can also have an adverse affect on their future mortgage rates. Foreclosure is an item that is asked about specifically in credit inquiries. There is no seven-year time limit on this credit item.
3. Your credit score. If you let a home foreclose, your credit score will be hit 250-300 points and will likely not recover for at least 3 years or more. With a short sale scenario, the affect of the credit score is much less significant and after the fact the debt shows as “settled for amount less than owed” on the credit report and should roll off of one’s credit report in 12 to 18 months. It looks the same as someone who’s settled a credit card balance. Recently I had a client who had immaculate credit and she did not want to ruin her credit rating. We attempted to do the short sale while she continued to make payments on the loan. The short sale was nearly approved when the bank (who happened to be Chase) came back and said, everything looks great – but its not a hardship because she’s still paying the mortgage! (Little did they know she was down to $300 in her bank account by that point!) As a Realtor I can never legally advise a client to stop paying the mortgage, but upon hearing this and given the situation, she finally decided to go 30 days late and Chase approved the sale. Her credit likely took a small hit because of the one 30 day late but nothing compared to what a foreclosure would have done to her rating.
4. Credit History. When you are foreclosed, it will remain on a person’s public record in credit history for up to 10 years. With a short sale there is no reporting category for this, and it will state “paid, settled for amount less than owed” and should roll off in 7 years or less.
5. Security Clearance. Foreclosure is the most challenging issue against a security clearance outside of a conviction of a serious misdemeanor or felony. If a client has a foreclosure and is a police officer, in the military, in the CIA or any other position that requires a security clearance, the clearance will be revoked and the position will be terminated. However, a short sale on its own does not challenge most security clearances.
6. Negative in Employment Credit Checks – Many employers run credit checks on prospective employees. Foreclosure is one of the top items that will put a potential new hire in jeopardy. If the employer feels you can’t manage your personal finances, they may feel that you can’t manage things at their company, either.
7. Potentially Damaging in Current Employment – Many current employers run credit checks. A foreclosure can put a current position in jeopardy. Same reason as above.
8. Lower Tax Liability than Foreclosure – The tax liability in a foreclosure may be much higher than in a properly negotiated short sale since canceled debt will be higher in a foreclosure.
9. You Have Alternatives – As your expert, I will explore every option with you and work toward the best resolution. Some lenders are offering financial incentives right now. I had one homeowner who was offered $5,000 at closing if she got her short sale closed within 30 days. Another one was offered $20,000 to complete a short sale. These incentives vary from lender to lender – call us for further details.
10. Do Everything You Can – While it may not seem like it now, there will come a time when your current financial troubles will pass. You will feel much better knowing that you did everything you could to avoid this devastating financial consequence that so many people face today.
If you are considering a short sale on your home, please speak to a real estate attorney first, and then make sure you choose a real estate agent who is experienced with listing and getting short sales CLOSED. We use a professional negotiator service that we work in tandem with to get our short sales closed fast – and we never charge our sellers a dime. The bank pays all fees. We currently have a 100% success rate getting our short sales successfully closed with the banks!