A recent development arising from the collapse of the housing market has been the rapid increase in the real estate industry practice known as short sales. As more and more homeowners find themselves in the precarious position of owing more on their homes than what they are currently worth, many homeowners have begun to consider whether taking part in a short sale might be more beneficial than going through with the normal foreclosure process or filing for bankruptcy protection. Although for some individuals a short sale might appear more beneficial than other traditional options, in many cases there are significant drawbacks to taking part in a short sale, and a host of problems that the seller does not discover until later. Before you proceed with a short sale you should consider what is discussed in this article and ask critical questions of the people who are proposing this transaction to you. In a real estate short-sale, the struggling homeowner sells his or her home for less than what is owed in hopes that the lender will accept this amount in satisfaction of the mortgage debt. Lenders are likely to agree to a short sale only where the homeowner appears to be unable to continue making payments, and only where the property’s value is less than the mortgage balance. The difference between what is owed and the selling price is known as a “deficiency.” A short sale is really only beneficial to a homeowner if he can receive a guarantee from the lender that he will not
be liable for the deficiency. At first glance this all seems very beneficial to the seller. He has sold his home, avoided foreclosure, and received a release from his underwater mortgage. However, at this point there are a string of complicated unforeseen problems that might arise. A lot of times the seller will be surprised to realize that he is still liable for the unpaid balance owed on the mortgage. When a short sale occurs, the bank will almost always try to get the homeowner to sign a promissory note agreeing to pay back the deficiency. If you decide to take part in a short sale you need to make sure that you will not only be released from the mortgage, but released from personal liability as well. In Florida, if a lender is able to get a deficiency judgment, they can garnish your wages and levy your bank accounts. If you take part in a short sale, you need to make sure that the lender agrees to not pursue a deficiency judgment, since you are helping them out by not extending the foreclosure proceeding. The trick is that many lenders do not readily forgive deficiencies. Anyone who tells you that this regularly happens is not giving entirely accurate information. Many homeowners are also surprised to learn that a short sale can carry the same devastating impact on their credit score as a foreclosure. In many cases a short sale is also more damaging to your credit score than filing for bankruptcy. Since you are technically breaching your contract, the lender has the right to report that you did not pay the balance in full. If your credit is in good standing at the time of the transaction, it is not unheard of for your score to drop 200 points as a short sale is considered a serious delinquency. Although a short sale is potentially devastating to your credit score, most creditors see short sale sellers as being less risky than debtors who have gone through foreclosures. There are also a host of serious and complicated tax issues that are associated with short sales. One of the benefits of filing for bankruptcy protection is that you are established to be insolvent which means that any debt forgiveness received should not be considered income or a taxable event by the IRS. If you get debt discharged as part of bankruptcy, you do not owe taxes on the debt forgiveness. This is not always the case with a short sale as the IRS considers the amount of the debt that you didn’t pay as taxable income. The Mortgage Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principle residence. However, determining eligibility and becoming eligible for relief under this Act is very complicated, and should not be undertaken without the assistance of an experienced tax attorney. Additionally, debt forgiveness on a second home or investment property will result in taxable income. The fundamental purpose of bankruptcy is to give an insolvent debtor a fresh financial start in life. By entering into a short sale transaction that does not conclusively resolve the debt, you are not solving your financial problem. You are delaying your financial “reset” which may not be a wise course of action. Furthermore, based on our experience consulting with clients, a short sale takes, on average, six months to accomplish. In many cases by the time the bank agrees to a short sale, the buyer has already left the transaction, and the homeowner is right back to where he started. Also, if there is more than one mortgage on the home, a short sale is even more difficult to accomplish since all the lenders have to agree to the transaction. At a minimum prior to entering into a short sale transaction you should ask yourself whether the issues raised above have been resolved. At the Martin Law Firm, we understand that the current economic conditions have made it difficult for many families to afford their house payments. It is important to keep in mind that there are a variety of options available to homeowners who are behind in their mortgage payments and facing probable foreclosure. It is also important to understand that every situation is different, and in some cases taking part in a short sale might indeed be the best option for the homeowner. There are advantages and disadvantages for each option and before deciding on a course of action, it is important for the homeowner to contact an experienced attorney so that they can make the best decision for their situation.