A short sale might be your best alternative. But they can be hard sales to close, and may not accomplish what you hope.
Someone Doesn’t Get Paid
In a short sale, you sell your house by “shorting”—underpaying—one or more of the lienholders, because the sale price is not enough to pay everyone in full.
In the depths of the recent real estate crash, a large percentage of home sales were short sales because the value of so many houses had fallen below what was owed on them. Even though property values have climbed in many parts of the country, there are still millions of homes “under water,” and so can only be sold in a short sale.
Why Short Sales Are Harder to Close
You can imagine that if a mortgage holder or someone else has a lien on your home and a legal right to be paid in full, it will be reluctant to take anything less than payment in full before releasing its lien. And these lienholders can include not just voluntary ones like your first and maybe second mortgage, but also judgments, income taxes, support obligations, unpaid utilities, and property taxes. Generally all lienholders must consent and release their liens, or the sale cannot occur.
Beyond getting out of a house that you can’t afford, the main benefit of a successful short sale is that it avoids a foreclosure on your credit record. Although in general that is a sensible goal, a short sale is also likely detrimental on your credit record—after all you are not paying one or more of your creditors in full. Also, given how many millions of foreclosures occurred in the last 5-6 years, there is some indication that there is and will continue to be less credit record difference between a short sale and a foreclosure. Depending on the rest of your credit record, now and in the future, focusing on avoiding foreclosure may not be as important as you may think.=
Short Sales Often Do Not Come Together
Most short sales take much more effort and time to pull off than expected, so they usually take longer, and then often fail to close, putting the homeowners further behind and no better off. The reasons they often don’t work are:
- Unhelpful and slow mortgage lenders: In a short sale usually the first mortgage holder has to give some money from the sale proceeds to a junior lienholder or two. The only reason the first mortgage holder would do that is if getting a little less out of the sale is better than going through the delay and cost of a foreclosure. Although many mortgage lenders have gotten better organized and staffed to process short sales, working with them can still be like pulling teeth.
- Any lienholders can refuse to cooperate and kill the deal: When the pie that is too small, it’s hard to make everybody happy and cooperative. Any lienholder can refuse to take the proposed reduction in payment and jeopardize the closing.
- The realtors and other middlemen often have the most to gain: Realtors and others in the real estate sales industry often benefit more from a short sale than you do. There are good reasons that unbiased observers—like bankruptcy judges—tend to discourage short sales.
Short Sales Can Be Dangerous
You could end up legally liable to those lienholders who were not paid in full, and could also potentially owe extra income taxes.
- Unpaid balances on the junior mortgages and liens: You may be told that you will not be liable on debts that aren’t paid in full from the home sale, but that’s not always true. You need to be sure that the settlement documents and the applicable law in fact cut off any liability. Be careful about feeling forced to accept some remaining liability just to get the deal done.
- Potential tax consequences: This issue is a complicated one that can’t be covered here in adequate detail. The main point is that debt forgiveness can be treated as income subject to taxation unless you fit within one of the exceptions. Make sure you talk with an appropriate tax specialist about this before investing any time or expectations in the short sale option.
Short sale attempts often fit two wise rules of thumb: 1) desperate actions often lead to no good, and 2) if it sounds too good to be true, it probably is.