Short Sales: Seldom Easy and Often Not What You Expected
A short sale of your home is sometimes your best alternative. But short sales often do not successfully close, and even when they do you must be vigilant to avoid problems later.
In a short sale, a house is sold by “shorting”—underpaying—one or more of the lenders (or “lienholders”), because the value of the house, and thus the purchase price offered by the reasonable buyer, is not enough to pay everyone in full. The liens can include not just voluntary ones such as the first and second mortgage, but also judgments, income taxes, support obligations, unpaid utilities, and property taxes. All lienholders must consent and release their liens, or the sale cannot occur, because the title needs to be clear for the new buyer to be in full ownership.
The important thing to know is that unless you get a full settlement or satisfaction in writing you may face continuing liability to any creditor who was not paid in full, even after the sale! This is why it is important to work with competent and knowledgeable professionals in dealing with any short sale situation.
The primary benefit of a short sale is that it avoids a foreclosure on the homeowner’s credit record—that is, it does so IF the short sale is successful. Generally, the most common current underwriting criteria will prevent a borrower from qualifying for a new home loan for up to 7 years after a foreclosure, but only 2-4 years after a short sale. (However, given the present economic climate, in the future there may be less credit record difference between a short sale and a foreclosure.) This credit record difference is often the primary reason borrowers will try to do a short sale, instead of just letting a property go to foreclosure.
Short sales can have problems, however.
First, they can be much harder to pull off than expected, and can take much longer than expected. It is also possible they fail to close, typically due to servicer/lender rejection of reasonable purchase offers, which can be very frustrating to all parties involved. Short sales may also fail due to:
- Lack of incentive of the Servicer: Many mortgage companies are not well organized or staffed to handle short sale negotiations. Borrowers and agents generally must work through a servicing company, whose financial incentives may well not encourage short sales. So they may drag their heels, and can even sabotage your efforts, even after months of submitting documents and reasonable offers. This causes many would-be buyers to get frustrated and walk away from the deal rather than keep trying in the face of such adversity and frustration. LAck of responsiveness of servicers is a major cause of short sale failures.
- Since all lienholders must agree, any one of them can kill the deal: To accomplish a short sale, usually the first mortgage holder has to give up some money to a junior lienholder or two. The benefit to the first mortgage holder is that getting a little less out of the sale is better than incurring the substantial costs and delay of foreclosure. However, they may not be willing to allow enough money to a junior to entice all parties to allow the short sale to be completed. Everybody wants their “fair share” of a pie that is too small to make everybody happy. So just when you think you have a deal among the main players , someone else crawls out of the woodwork demanding a payment and jeopardizing the closing. They all have a legal claim against the property, and can delay or undo the whole deal.
- Closing and other costs can be too high: Sometimes after adding up all the closing costs and realtor fees, there may not be a high enough “net proceed” number to entice the lender to do the deal. Of course, the realtors and their negotiating agents are doing a lion’s share of the work in any short sale process, and must be adequately compensated by the lender at closing. This is how a short sale can be done with little or no out-of-pocket cost to the borrower. Sometimes the banks have a hard time with this concept and will lead to a sale failure by their rejection of reasonable market offers. This just means they will actually lose more money in the long run, and it is frustrating for everyone involved, particularly the realtors and others who put substantial time and efforts into the process only to have it fail due to a recalcitrant or incompetent servicing agent.
Short sales can be dangerous if you are not well-informed:
- Potential liability from unpaid balances on the junior mortgages and liens: Although you may be told that you will not be liable, you need to be sure that the acceptance and/or settlement documents and the applicable law in fact cut off any financial liability to you following the sale. Also be aware that sometimes in the midst of the negotiations, especially if a junior lienholder is playing tough, and the closing has been delayed for a long time, you may be feel forced to accept some liability in order for the closing to occur. This may or may not be in your best interest, and you may wish to consult with an attorney to discuss all the factors and options – be sure to consult with someone who is unbiased and who will advise as to your interests alone (unlike realtor or others who may only get paid upon sale).
- Potential tax consequences: This issue deserves a whole blog by itself. The key principle 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 or attorney about this before investing any time or expectations in the short sale option. Most residential borrowers will have an exception, but not always!