We represent many clients who own a home or condominium and are “underwater” on their mortgage – or, in some cases, on multiple mortgages on the same residence. Some simply find themselves unable to continue servicing their debt. Whether they’ve lost their job, their mortgage rate has adjusted upward, or their home’s value has plummeted far below the debt owed, these homeowner find they have no choice but to get rid of their home and debt(s). This leads them to ask a question I hear often:
Does it make any significant difference whether I sell my house in a “short sale” or simply let my lender foreclose the property?
The first step in answering this important question is understanding the difference between a foreclosure and a short sale.
There are two types of foreclosure: Judicial and non-judicial foreclosure. Most lenders pursue the latter approach, a non-judicial foreclosure.
- Non-judicial foreclosure. Under Washington law and pursuant to the terms of your loan, the lender can provide notice to all parties with a recorded interest in your home and, after a waiting period, the lender can sell the home on the courthouse steps to the highest bidder. Typically, if your outstanding loan is significantly higher than the value of your home, then no outside bidder will make a high enough offer to pay off the debt, and the lender will simply take possession of the property, and will try to market and sell that property at some later date to recover as much as possible.For you as the homeowner, there is a significant benefit to a non-judicial foreclosure: Your primary lender cannot pursue you for any “deficiency” judgment. That is, if you have a $300,000 balance on your loan and, at the foreclosure sale, the lender accepts a bid of $250,000 for the property, the lender cannot pursue you for the $50,000 shortfall.However, note that only the foreclosing lender – typically your primary lender – is barred from pursuing you for a deficiency. If you have a second loan, such as a HELOC (Home Equity Line of Credit), then that debt is not wiped away by the foreclosure sale – even if the HELOC was issued by the same lender as that on the primary loan. So, homeowners who have multiple loans on their home may better protect themselves by pursuing a short sale rather than a foreclosure of their distressed property.
- Judicial foreclosure. In a judicial foreclosure, which we rarely see lenders pursue as a remedy, the lender files a lawsuit on the promissory note that you signed to get your loan. The lender can then get a judgment in its favor for the full balance of the loan and foreclosing the property, which transfers title and rights of possession to the lender. However, the time and expense that it takes to complete a judicial foreclosure, and the possibility of defenses being raised by the borrower that further delay a definitive result, as compared with a relatively “clean” non-judicial foreclosure.
- Possession of the property. The purchaser of your property at a foreclosure sale is entitled to take possession 20 days after the sale.
In a short sale, your home is sold at a price that yields less money for the lender than the amount owed on your property. Keep in mind that if you try to sell your home for $700,000 and you have mortgages totaling $675,000, the “net” to your lender will not be enough after deduction of real estate commissions, excise tax, and other closing costs. A sale at that price would be a “short sale” and would require approval by your lender.
- How to pursue a short sale.
- The first step in pursuing a short sale is to advise your lender of your dire financial situationand your inability to continue servicing the loan.Ironically, it is sometimes difficult to get a lender to take your situation seriously until you are at least two months delinquent on your loan.However, it is increasingly common that lenders make available on their websites useful information and forms for financially distressed homeowners wishing to get the short sale process going. (This often includes information on how to get a loan modification, which is another form of debt relief not addressed in this article. Pursuing a loan modification may be appropriate before pursuing a short sale.) Typically, lenders require detailed information on your finances, including recent pay stubs and bank account statements. You will also need to write a hardship letter to explain your situation.
- Virtually all lenders require “proof” that a house can only be sold at a short sale price. Most often, sellers provide this proof if they first market your home for at least three months, with a competent realtor, at a price that is adequate to pay off the loans in full. Only after unsuccessfully marketing the home at “full” price will you be able to convince your lender that a short sale price is necessary to generate an offer and a sale. So, find a good realtor to market the property, and be up front with him or her about your financial situation and the possibility that this may be a short sale. You will be best served by a realtor who has had success handling short sales.
- If you get an offer at what would be a short sale price, or you make a counteroffer at a short sale price, make sure your Washington realtor includes a Form 22SS as part of any acceptance or counteroffer.
- Why lenders like short sales. After the 2007-08 real estate crash, many lenders were ruthless in refusing to negotiate with their distressed borrowers. They would simply foreclose on properties and add them to their “REO” (real estate owned) inventory. However, the consequence of that was tens of thousands of foreclosed homes that lenders – who are in the money business, not the property management business – had to maintain, market, and sell. After a few years and way too many homes on their books, lenders realized that they would often be better off taking the “haircut” on a loan without ever owning and having to resell the property. Thus, short sales have become increasingly popular among lenders as a way of dealing with their loans on distressed properties.
- Why sellers like short sales. For a distressed homeowner, a short sale may have several advantages. First, if you are not servicing your loan for the duration of your marketing of the property, you may be able to live “rent free” during that timeframe. Note, however, that if at all possible, you should continue to pay any property taxes, insurance, and homeowners dues or assessments, as you can remain personally liable for those debts even after a foreclosure or short sale, absent an agreement to resolve those debts with the short sale revenue or by other means. A second instance in which a short sale may be preferable to a foreclosure is for homeowners who have more than one loan on their home. In a short sale, all lenders need to approve the sale. This gives you an opportunity to negotiate a resolution with your second lender, thereby reducing or eliminating your obligation to that second lender. (By comparison, as noted above, a foreclosure by your first lender does not eliminate your debt to your second lender.) We have successfully negotiated with multiple lenders on several short sales, sometimes eliminating the second debt and other times getting the second lender to accept as little as 11 cents on the dollar.
- How a lawyer can help you with a short sale. Your lender is not your friend. It is your creditor, and probably your biggest one at that. There are several ways that a lawyer may be able to help you with the stressful and difficult process of dealing with your lender through the short sale process, including the following:
- A short sale is, by definition, a negotiation with your lender. A lawyer experienced in this area can help with all aspects of this negotiation, including communicating with the lender representatives, helping with the preparation of your financial documents and hardship letter, and developing arguments and evidence regarding the realistic value of the property, to persuade the lender that it should accept a lower number.
- If you have a second lender, this negotiation becomes extremely critical because that lender is often hesitant to accept a significant “haircut” on its loan to you.
- Lenders sometimes try to pressure borrowers by misstating the law. For example, your 401K retirement account may not be a target for creditor, yet we have seen creditors imply that the borrower’s retirement account will be pursued if the creditor’s loan is not paid in full. A lawyer can help you push back on a lender engaged in such tactics.
- Anything involving your home and your finances can be very stressful, and this stress can do serious and sometimes permanent damage to your relationship with your spouse or life partner. Placing this problem into the hands of a capable lawyer can help alleviate that relationship stress in a huge way. Your lawyer can help both of you understand and work through the risks and benefits of various courses of action, without one spouse feeling either responsible for, or at the mercy of, their spouse or partner.
Don’t underestimate your lender’s selfish motives, or the variety of strategies that might be employed to protect your interests and maximize your result, or the stress that a short sale negotiation can place on your most valued relationship. An experienced lawyer can help you effectively deal with all of these important realities of the short sale process.
Can I be taxed on the debt that is forgiven or eliminated?
Under the Mortgage Forgiveness Debt Relief Act, you can obtain up to $2 million in tax relief ($1 million if married and filing separately) on forgiven debt. Although the Act is set to expire at the end of 2012, in August 2012 the Senate Finance Committee approved extending the Act through 2013. So it looks as if this tax relief will continue at least through 2013.
Here is a link to IRS information on the Act:
Can I sell my appliances, cabinetry, or other fixtures in my home before a foreclosure or short sale?
Homeowners sometimes think that they are entitled to “sell off” appliances and other fixtures, either because they bought them separately after buying the home or because these items are not really part of the “property.” However, in Washington, any such effort is a gross misdemeanor. In short, don’t do it.
How does a short sale or foreclosure affect my ability to buy another house?
There is a difference of opinion as to whether a short sale has any less damaging effect on your credit score than does a foreclosure. Your score is going to take a hit either way, though perhaps less of a hit if you stayed current on your loan all the way until the foreclosure or short sale. Based on FHA and FNMA rules, if you did not stay current on your loan, it is likely that you will have to wait at least two years to buy a home using such loans. Lenders and specific loans may vary, and these rules change regularly, so check for yourself, including with an attorney, regarding what the current restrictions may be.
NOTE: Your own situation is unique. Your house, your loan(s), and your personal and financial situation each all a critical role in determining the right course for you as you seek to minimize or eliminate your liability and stress while extricating yourself from your financially distressed property. Because of that, you should consider consulting with an attorney to help determine whether a short sale, foreclosure, or other possible approach might be right for you. This article is for informational purposes only and is not intended to provide legal advice.