Keep in mind when reading the information contained herein, that you should obtain professional legal and tax advice before making a decision about whether to choose a short sale, deed in lieu of foreclosure or a foreclosure.  Each home owner has a unique set of circumstances that will affect the outcome of your decision, there is no “one size fits all,” solution.

Overview:

If you want to sell your house but its’ worth less than the amount you owe on the mortgage, a short sale may allow you to sell your home and settle your mortgage debt for less than the balance you owe.

Completing a short sale rather than allowing your home to go through foreclosure, you avoid eviction and your house will not be sold at a public sale or auction.  Depending on your circumstances you could qualify for financial assistance to help you relocate after the home sells. (HAFA – see below). Through a short sale the lender agrees to accept less than the balance owed on the mortgage at sale. The deficiency balance is forgiven, typically.

However, it has been reported that some mortgage companies are asking borrowers to agree to accept liability for the deficiency balance. The lesson here is if you are considering a short sale, you must review the terms and conditions carefully and make certain you understand whether the deficiency balance is forgiven.

Eligibility:

You may be able to sell your home in a short sale if:

·         You have a hardship such as job loss, curtailment of income, divorce, illness, etc.

·         You owe more than your house is worth.

·         You’re unable to afford your current monthly mortgage payment.

·         You’re unable to modify your current home loan.

How does a short sale affect my credit?

In regards to your credit score, the negative credit impact of a short sale is less than that of a foreclosure. A short sale will not appear as a foreclosure on your credit report, and therefore only the previous delinquency on your mortgage will appear. Also, most mortgage lenders report a mortgage that is paid through a short sale as being in a redemption status.

Although the delinquency and change of status on your mortgage loan will certainly lower your credit rating,  the negative impact is less than the negative credit implications of an actual foreclosure. If you must choose between a short sale and allowing your home to go into foreclosure, from a credit perspective, a short sale is the wiser choice.

Generally speaking, lenders will continue to report the status of your account to the major credit reporting agencies and if a short sale is completed they will, more often than not, report that your loan was “paid in full for less than the full balance.”  The actual hit to your credit will also depend on whether or not you are delinquent on just mortgage payment, or on many of your bills.

Will I get money back after I sell my house?

Because a short sale would allow you to sell your home for less than the amount you owe, you would not receive any money back at the time of closing.    However, if you are qualified for a HAFA short sale, you will receive $3,000 for relocation assistance.

One last point regarding short sales: a lender is required to file a 1099C if the debt forgiven exceeds $600. As mentioned in the deed in lieu of foreclosure section above, The Mortgage Forgiveness Debt Relief Act offers former homeowners relief for forgiven debt.  Mortgage Forgiveness Debt Relief Act of 2007

HAFA - Home Affordable Foreclosure Alternative

What is HAFA?

The HAFA program is sponsored by the federal government, with the common goal of helping borrowers with an alternative way in avoiding foreclosure. A short sale or deed-in-lieu (DIL) is the best choice for both the lender and the borrower because the home will maintain its value better when occupied, and the borrower gets to reduce their debt load with no deficiency judgment against them.  Unlike a traditional short sale, in a HAFA approved short sale the lender must agree to release the seller from any deficiencies.

If you were not able to get your loan modified, this is the best option for you since a foreclosure or bankruptcy can affect your credit for 7-10 years.

In addition, there is NO COST for the program and you will also receive a $3000 incentive at closing.

CAN YOU QUALIFY?

The Home Affordable Foreclosure Alternative (HAFA) ends December 2012. In order to qualify, the following criteria must be met:

·        Must be your primary residence

·        Less than $729,000 on 1st mortgage only/2nd loans okay

·        Must have a financial hardship (i.e. job loss, reduced income, divorce, etc.)

  Mortgage payment, including taxes & insurance must be over 31% of borrower monthly gross income

·        Loan originated before Jan. 1st, 2009

 Deed in Lieu of Foreclosure

A deed in lieu of foreclosure is another alternative to foreclosure. In a deed in lieu of foreclosure, the property owner gives the property to the lender voluntarily in exchange for the lender canceling the loan. The item transferred is the deed to the property. The lender promises not to initiate foreclosure proceedings, and to terminate any foreclosure proceedings already underway. The lender may or may not agree to forgive any deficiency balance that results from the sale of the property.

Potential tax liabilities

An overlooked downside to a deed in lieu of foreclosure is the possible forgiveness of the deficiency balance. Under federal law, a creditor is required to file a 1099C whenever it forgives a loan balance greater than $600. This may create a tax liability for the former property owner because it is considered "income." However, the Mortgage Forgiveness Debt Relief Act of 2007 provides tax relief for some loans forgiven in 2007 through 2012.

The key issue in a deed in lieu of foreclosure is whether the lender is willing to forgive the deficiency balance. Read the contract carefully to see how the deficiency balance issue is handled. If the document is unclear, take it to an attorney with experience in property law. An attorney's time is not cheap, but will be a bargain compared to signing an agreement you do not understand and are surprised later to realize its implications.

Many lenders would rather agree to accept a short sales because they do not want to own the distressed property. They would much rather see the owner sell the property and lose the deficiency balance than be forced to take the property through foreclosure, as foreclosure is a costly and time-consuming process.

Here is the typical list of deed in lieu of foreclosure: a) the residence must already be on the market for a certain number of days (90 days is typical), b) there can be no liens on the property, c) the property cannot already be in foreclosure, d) the offer of a deed in lieu must be voluntary, e) the house must be priced reasonable.

What if the lender rejects a short sale or a deed in lieu of foreclosure?

If the lender will not allow a short sale or a deed in lieu of foreclosure, foreclosure is the last option, although it presents major problems. Foreclosure auctions tend to bring significantly less money than a normal sale would bring. If the sale brings less than the amount owed on the loan, the remaining balance of the loan is called a deficiency balance.

If the home falls into foreclosure, it is possible to mitigate the negative impact of a deficiency balance by filing bankruptcy.  Generally speaking, deficiency balances are treated like any other unsecured debt in bankruptcy, meaning that they can be wiped clear by Chapter 7, and repaid over time through a Chapter 13. Although bankruptcy does not sound like a positive alternative, it may be the best solution if the mortgage lender will not allow the home to be sold through a short sale or a deed in lieu of foreclosure.

Lastly, I urge you to consult with an attorney experienced in bankruptcy law to understand all of your options to resolving your mortgage debt.