Foreclosure – Understanding the Pros and Cons of the Short Sale

June 12, 2011 0 Comments

Foreclosure – Understanding the Pros and Cons of the Short Sale

Homeowners facing foreclosure in California have approximately 120 days from the Notice of Default (about 4 months) in order to resolve their outstanding mortgage debt. When a homeowner finds themselves in this situation, the most proactive step a homeowner can do is to act in a timely manner to get a realistic look at what their options may be. There are many choices that a homeowner can choose from in order to best reduce the overall loss during the stressful financial situation they may find themselves in; however, denial shouldn’t be one of them.

In the slew of options that are available, there is a little-known transaction known as a “short sale” which to some homeowners in foreclosure may seem like a dream come true. Short sales occur when a lender allows a homeowner in default to sell a house for less than the total value of the loan. In many cases, the lender then forgives the remaining portion of the debt. But before a homeowner who finds himself in foreclosure gets too excited about what seems like welcome debt relief… there is a catch.

So what’s the catch? Lenders may claim whatever debt they’ve forgiven as a loss on their taxes and issue a 1099 form to the homeowner; in this case the seller, for the total amount. In other words, the forgiven debt is taxed as earned income and depending on the loss and the homeowner’s (and potential seller’s) tax bracket it could mean a significant increase in their taxes. A homeowner should definitely check with his accountant for this information. On the other hand, if a property is sold under a short sale, the lender may require the buyer to make up the difference, either through a personal obligation or a collection for the remaining balance often referred to as a deficiency judgment. According to Barron’s banking dictionary, the definition officially is… ” A court order authorizing a lender to collect part of an outstanding debt from foreclosure and sale of the borrower’s mortgaged property or repossession of property securing a debt, after finding that the property is worth less than the book value of the outstanding debt.”

While lenders will traditionally pursue other loss mitigation methods to work with the homeowner, when it seems very unlikely that the homeowner will be able to pay pack the debt– the lender may choose to agree to a short sale in order to avoid further financial losses. Admittedly, this “win-win” situation involves parties who have already resigned themselves to losing their home and walking away from their obligations with a lot less damage to their credit. And as for lenders, they know that repossessing the home (probably with a declining value) will cost them thousands of dollars to maintain, refurbish, market and sell, with no guarantees that it will recoup the same amount it might have gained from a short sale. By the same token, homeowners understand that foreclosure will not only take away their home but also deliver a “black eye” on their credit that will stay that way for at least seven years. With that in mind both parties may be willing to negotiate a short sale; however, the lender ultimately has the last word on whether this is an option they will allow.

Another good reason that a short sale might be desirable is that the surrounding neighborhood and community at large may benefit from homeowners opting for short sales instead of foreclosure, as these types of sales are not as heavily discounted as foreclosure auctions. These sales may help “mitigate drastic decreases in the values of nearby properties.”

For a homeowner considering this option, there will be a lot of details that will need to be addressed and negotiated with the lender. If your bank agrees to a short sale, the homeowner then hires an agent to find a buyer for the house, sells the house at a loss, and with the bank’s approval, they agree to take the loss incurred. To be sure, as trying as it may be under the circumstances, a homeowner should try to maintain courteous and professional communications with their lender at all times. This open communication can markedly improve the possibility of a timely, smoother transaction and adequate solution for all parties involved. A homeowner will literally be racing against the clock and anything he or she can do to facilitate the process, will result in a much more positive outcome than it might otherwise be.

In addition, the homeowner should be diligent to find a professional realtor who understands short sales well and has the experience in working with lenders and banks before giving the potential realtor the listing and hiring him or her to sell his house. As paperwork intensive as a regular real estate transaction can be, the paperwork and negotiation process will escalate during a short sale and lenders will be scrutinizing for any irregularities in the transaction. Not surprisingly, too many distressed homeowners often try to sell their properties to family members or other relatives. A lender will be wary of potential buyers with a vested interest. As a result, a homeowner will need a professional who understands loss mitigation procedures and the ins and out of short sales and is able to successfully negotiate with the lender.

Where exactly did short sales come from? While the history is not very clear, the idea grew out of the down market of the early 1990s, when lenders were eager to find new loss-mitigation tools to avoid becoming real estate investors and property managers instead of what their core functions were as banks–lending money and collecting interest.

Once the boom began and foreclosure rates dropped, few people needed short sales. Now, as adjustable loans begin to reset and with many real estate markets currently in decline, short sales are beginning to show up in the market again.

Nef Cortez has been a licensed real estate broker and has held various positions in the real estate and mortgage industry for over 25 years. If you would like to read more of Nef’s pithy and timely advice (with the latest info on local foreclosures), visit his website at Chino Hills, CA homes [http://www.nefcortez.com] or read his blog at Southern California Real Estate Blog [http://www.nefcortez.com/newhomes]

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