Is a short sale the end of your problems? Or just the beginning?

Are short sales looking good to you?  (Active rain.com)

Most people think that a short sale will solve their financial problems, but sometimes it can be just the beginning of new problems that were unforeseen, and for which they might not have been prepared.

A short sale is when a lender agrees to accept less than the amount owed against a home because there is not enough equity to sell and pay all the costs of a sale. It is for homeowners who are underwater, and experiencing financial difficulties. Most short sellers are those who have tried to refinance or modify their current mortgage but have not succeeded. Not all lenders will negotiate a short sale, which is why a real estate agent or a lawyer can be a tremendous help. These professionals will contact your lender's loss mitigation department to find out if a short sale is a possibility for you.

You can't just wake up one morning and decide you're going to sell your home at a loss, and then ask for a short sale; and don’t even think about putting your house up for “Sale by Owner” with a sales price below what you owe on the mortgage(s). Your best bet is to work with a realtor or attorney who specializes in this process. My suggestion is that you hire a realtor who is an expert in short sales to guide you. Your lender will require that the property be listed for sale with a realtor in any event, so you might as well get that expert working with you right out the gate.

A reputable realtor will advise you to talk with both an attorney and your CPA before you start this process. Realtors are great resources, but they are not attorneys or accountants. Banks will do whatever they are legally permitted to do, to protect themselves, so you should do the same.

In Portland, we have a many qualified realtors who specialize in short sales. Todd Burton, of The Burton Team is one of the leading experts in this area, with more than 20 years experience in this field. Todd works short sales a little bit differently than some other realtors, who try to negotiate a short sale with the lender(s) prior to ever listing the house for sale. Todd says that the best way to get a lender to agree to a short sale is a multi-step process, but starts with listing the house for what is owed on the mortgage(s). Every Friday, after the house is listed, Todd drops the price at least $10,000 (more for more expensive homes), until an offer is received. Once he has an offer, then he begins negotiating with the lender(s). He says his listed houses are typically on the market only 4 -5 weeks before an offer is received. (Remember that houses have started selling again in the Portland area, and of course, all the buyers out there are bargain hunting.)

Todd does not recommend that you be delinquent, or already in the process of foreclosure prior to consulting with him. However, his experience has shown that most lenders won’t even talk to him about a short sale if the seller is not already late on their payments.

Once a buyer makes an offer, it typically takes three to six months to get a loan closed, and the seller out from under the debt. Todd has two sales he closed this year that actually took 16 and 18 months to close. Here’s why this could happen:

Todd deals with a lender’s loss mitigation department. While a loss mitigation expert may sound like an impressive title, this is a tough job, so turnover is relatively high with these employees. If the loan does not close relatively quickly, (and of course, the seller is delinquent on payments), the loan can go into foreclosure. Many banks have separate loss mitigation and foreclosure departments, so Todd may have to start his negotiations all over at this point. He has actually had properties foreclosed out from under a potential buyer, even with his constant contact with lenders. However, he does make every effort to get lenders to extend the timeline on loans in foreclosure when he already has a well qualified buyer for the property. Unlike some other realtors, Todd never takes a “short sale” listed property off the market. He takes as many back up offers as he can get, because this is a lengthy process, and buyers sometimes lose patience and back out on the deal.

The most common question I am asked is “If I do a short sale, can the bank come after me for the difference between what I owe and what the house sold for?” The answer, unfortunately, is, it depends on where you live, and your lender. The first thing you need to determine is whether or not you live in a “non-recourse” state, or a “recourse” state.” Following is a list of “non-recourse” states:

Alaska                                                Missouri
Arizona                                               Montana ** (if a non-judicial foreclosure is used)
Arkansas                                           Nevada** (the lender can still get a deficiency judgment)
California**                                       New Hampshire
Colorado                                           Oregon
District of Columbia                        Tennessee
Georgia                                              Virginia
Hawaii                                               Washington**
Idaho                                                 West Virginia
Mississippi
Texas** (even in a non-judicial foreclosure, the lender can pursue a deficiency)

A non-recourse state is one in which the lender cannot come after you for the loss sustained, IF…. this is where it gets touchy. Technically, non-recourse laws pertain to foreclosures.  Short sales are not foreclosures, and this is why you need an expert to negotiate on your behalf. Once you have a legal contract signed with the lender, be sure to have an attorney check it out, to make sure there are no loopholes. It is critical that you get a signed contract from the lender before you complete your sale, so the lender has to honor any negotiated terms.  (Note:  To date, I have not heard of any lenders pursuing deficiency judgments in Oregon.  However, some of the big banks are aggressively pursuing these judgments in Washington, so be careful out there.

If you have both a first and second mortgage, you must negotiate a separate agreement with both lenders. Technically, second mortgage lienholders are not bound by non-recourse rules. In many cases, second mortgage holders can and will pursue your non-payment of the debt.

In addition to those states that can “go after” you for losses by filing judgments against you, there may be tax consequences for a short sale. In theory, when you have a debt that is forgiven (as in a short sale), the lender is required to file a Form 1099-C with the IRS, so the amount “forgiven” is now taxable as income. However, in 2007, Congress passed The Mortgage Forgiveness Debt Relief Act and Debt Cancellation. This act has provisions that may or may not relieve you of the tax consequences. I strongly suggest that you contact your accountant or a tax attorney to determine if you are exempt from the tax consequences.

The next thing to consider is how a short sale will affect your credit score. Once a lender accepts your short sale, many lenders will report the debt you owed to the credit bureaus as “Paid – Settled.” (How your debt is reported is part of what a good realtor should be trying to negotiate for you.) IF you were not delinquent on your mortgage payments prior to the short sale, and the lender reports this debt as “Paid – Settled,” contrary to what you might have read or heard elsewhere, according to Experian.com, you could see a substantial drop in your score because you did not fully satisfy your debt “as agreed.” If you were delinquent on your payments prior to the short sale, the drop in your score could be almost as devastating as a foreclosure (300-500 points). The actual effect on your score is dependent on many factors, including:

1. The length of your credit history
2. How the loan payoff is reported to the credit bureaus
3. Your payment history to all your other creditors
4. Other derogatory information on your report
5. How much you owe to other creditors

Every credit history is unique, and each credit bureau has their own scoring methods, so the impact of a short sale on your score will differ with each credit bureau.

If you are thinking about short selling your house, so you can go out immediately and buy a less expensive house (which is what many people would like to do now, to take advantage of the low prices and great rates), think again. If your mortgage debt is reported as “Paid – Settled,” most lenders will not consider you for a mortgage for at least 2 years after a short sale. This is definitely less time that the 7 years “seasoning” requirement for a foreclosure, but who knows where housing prices or rates will be in two years? If you do find a lender willing to do your loan, you should probably expect to pay higher rates.

Short sale summary:
1. You must negotiate with both lenders (if you have more than one mortgage) and they MUST agree to the terms of a short sale.
2. If you live in a non-recourse state, or you have a second mortgage, you may find yourself in a legal battle with one or more of your lenders.
3. There may be tax consequences for doing a short sale
4. There may be credit score consequences for doing a short sale
5. You may not be able to buy another home for 2 or more years.

But again, all of the above depends most of all on the deal negotiated with your lender(s).

In the end, a short sale is not a decision you should make lightly. Definitely consider all the ramifications before you make this decision, but in the end, if it is your only recourse, be careful to protect yourself to the best of your ability, and utilize experts to assist you during this process.

Best regards,

Shelby

**Many states, such as California, do, in theory, allow a lender to choose judicial foreclosure but in those cases the lenders only do so if a borrower has significant other assets. This is the "one action" rule that lets the lender either pursue non-judicial foreclosure, at lower cost and less time, or judicial foreclosure that costs more money and takes more time but lets them go after you for their financial losses.

If you liked this article, here are some other articles that you might find useful, especially if you have not yet begun a short sale process or have not yet tried to refinance or modify your mortgage:

• Loan Modifications and the HOPE program, is it working?
• How to get a Loan Modification and Tips to Avoid Foreclosure
• Advantages of the HARP refinance program - Is this a good loan for you?