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Mortgage Debt: Short Sales

What is a Short Sale?

In simplest terms, a short sale is when you sell your home for less than is owed on it.  As you may imagine, this process must be approved by the lender and usually comes with lots of strings attached.  Nonetheless, as an alternative to foreclosure or bankruptcy, a short sale may be a good option for those who can no longer afford the home in which they live and the market says they can’t sell their home at an amount to pay back the loan.  If you are seeking a short sale, you are likely ready to move on and start over in a different home (probably one with lower payments). If this is the case, you need to be focused on selling!  This means staging the home, offering open houses, advertising the sale in every possible place you can think of, etc.  If your goal is to get out from under the burden of this house debt, focus on selling the home.  Let me repeat, FOCUS ON SELLING THE HOME.  If you’re lucky, you might not even need to short sell.  But if the market bears out that you can’t sell it for enough to cover your loan, just be aware you’ll need to get the bank’s approval for any offer amount that is less than the amount owed and thus you’ll be pursuing a short sale.

Short Sale vs. Foreclosure

The primary difference between a short sale and a foreclosure is the party who initiates the selling process.  Either way, the aim is to sell the property so as to satisfy a loan on that property.  In a foreclosure, the lender forces the sale; in a short sale, the borrower contacts the lender and asks to sell the property for an amount less than is owed.

Deficiency Judgments and Recourse

If you’re considering a short sale, there is nothing more important you’ll read in this article than this section.  While state law varies on this point, it is possible that a lender can sue you to collect any amount remaining on the debt after the proceeds from a short sale.  In other words, if you owe $100,000 on the home and short sell it for $90,000, the lender may have the right to sue you for the $10,000 difference.  This is called a deficiency judgment.  How do you avoid the deficiency judgment?  Two words: WITHOUT RECOURSE.  Any request you make with your lender to consider a short sale need to include the provision that it is an agreement without recourse.  Those two little words can save you THOUSANDS of dollars.

What are the Tax Implications of a Short Sale?

Like the implications of any debt forgiveness on your home, you should be aware that you may owe some tax money to the IRS in the event of a short sale.  Currently, The Mortgage Forgiveness Debt Relief Act of 2007 provides that in the event of debt forgiveness through a short sale on your primary residence, you should not have to pay income taxes on the debt forgiveness.  However, the provisions outlined in this act expire in 2012, so be aware and do a little research to avoid being surprised with a hefty tax bill.

Short Sales and Credit Ratings

As you might expect, like a foreclosure, a short sale will have a negative impact on your credit score.  According to Fair Isaac (the agency behind the FICO Score), you should expect your credit score to drop by 85-160 points in the event of a short sale. This is a massive hit that will probably keep you from being able to purchase another home (using a loan) for at least a couple of years.

Avoiding a Short Sale

Don’t put yourself at risk by buying more than you can afford!  If you must have a mortgage, make it one with a payment no more than 30% of your net (take-home) pay.  If you find yourself falling behind, don’t wait until it is too late before taking action.  Live on a budget every month that includes an emergency fund to help cover your expenses if your income takes a temporary hit.  Simply put, be smart and don’t overreach your income; and if you happen to get into trouble, don’t be afraid to ask for help.

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