estate planning

What You Need to Know About Short Sales

By Stuart R. Simone, Esq.

Many homeowners unfortunately find themselves in the stressful position of having to choose between selling their home in a Short Sale or losing their home to certain foreclosure.  The sad fact is that there are often other alternatives that these troubled borrowers are never told about.  This article will tell you the truth, the whole truth and nothing but the truth.

The word “Foreclosure” itself can often be scary enough to push some folks towards a Short Sale without fully understanding the possible drawbacks of the Short Sale process.  First off, Short Sales do not offer nearly as many as advantages over foreclosure as the general public has been led to believe.  Second, the sad fact is that many troubled borrowers may not even need to choose between only these two options.  For example, many homeowners can keep their homes with a Chapter 13 Bankruptcy, and others can sell their homes in “Subject To” deals that not only avoid the credit damage of a short sale or foreclosure entirely, but actually help BUILD their credit.  (See the links at the end of this article.)

Before we discuss “Short Sale vs. Foreclosure“, let’s make sure everyone understands these terms.  A “Short Sale” is like a standard real estate sale conducted by a Realtor, with the only difference being that the property must be “underwater” – i.e. the amount owed on the mortgage(s) is more than what the Realtor can sell it for.  From the lender’s point of view, they will be getting paid less than what they owed.  Thus a short sale cannot happen unless the lender approves the sale amount, and of course they will only approve it grudgingly.  That means that the lender won’t approve the sale unless the selling price is at least close to the loan amount, AND there are no other issues, such as any other liens on the property.  This makes the entire short sale process a very stressful process for the homeowner, as (1) the bank may not approve the buyer’s price, and (2) the lien and other issues may not be able to be resolved.  In either case the home could be lost to foreclosure.

Most people know generally what a “foreclosure” means; in short, it means that the foreclosing lender sells the property to pay off the mortgage balance.  Usually in California this is done when the Foreclosure Trustee holds an auction, and they sell the property to the highest bidder.  If the property is sold for more than what the borrower owes on all the valid liens, then the trustee is required to pay the borrower the “surplus” left over.  This is unlikely in a property that is supposed to be “under water,” but it is possible due to rising property values or perhaps a bidder at the auction has plans for the property.  (By definition, there is no possibility that the homeowner can get a surplus in a Short Sale.)

One of the biggest reasons that borrowers in default choose to pursue a Short Sale is because real estate agents or unlicensed “foreclosure consultants” often press the issue, trying to convince the homeowner that a short sale will protect their credit.  Unfortunately, this isn’t the case.  Property owners considering a short sale are already in default and delinquent on their mortgage payments.  At this point, the homeowner’s credit score has already taken a significant hit at 30 days delinquent (as much as 110 points) and another credit hit (an additional 70 to 135 points) at the 60 days delinquent mark.  The short sale itself appears on your credit report as a “Pre-Foreclosure in Redemption,” and the completed short sale can have a lasting impact on your credit score similar to a foreclosure or bankruptcy.  The hit you take from a Short Sale depends in part on how your lender reports the transaction to the credit bureaus, something the homeowner has no control over.  If the lender reports the deficiency balance – the amount of your mortgage balance that wasn’t repaid after the short sale – then the impact to your credit will be similar to a foreclosure.  Remember, the bottom line is that Creditor(s) – the mortgage lender(s) – took a loss on the loan in a Short Sale.

As if that isn’t bad enough, if the Short Sale does go through, homeowners need to know that if the value of the mortgage is higher than the value that your lender forgives through a short sale – which is nearly always the case – the leftover money is considered taxable income on an IRS 1099 and you will end up having to pay taxes on it.  For example, a home with a $500,000 mortgage sold in short sale for $450,000 leaves the seller with $50,000 of income that was never even received by the unsuspecting homeowner.  Very rarely do Realtors or “Foreclosure Consultants” mention this important fact.

And remember what we said above about the stress and hassle of the Short Sale Process.  First of all, in order to enter the Short Sale process, the borrower must hire a licensed Realtor or attorney.  The Realtor then must negotiate (beg) with the Loan Servicer’s short sale department, which then has to communicate with the owner of the note and try to convince them to take less money than what is owed.  This can take weeks or even months.  All this time, your home could be legally auctioned off by your lender if a Notice Of Trustee’s Sale has been recorded over 20 days previously.

Also, the bank will not approve the Short Sale until all liens have been cleared.  If there are other mortgages, that means paying off all Junior Lenders, which means another round or two of negotiations.  This can be a deal-breaker, as Junior Lenders often have set-in-stone policies that prevent them from selling below a certain %, even if it means that they would be wiped out 100% if the property was foreclosed.  (This makes no sense, but trust me, I’ve had clients that experienced this sad result.)  Oftentimes there are fraudulent or bogus liens that can only be cleared by a Quiet Title Lawsuit, which can take several months if all goes well, since a Quiet Title lawsuit cannot be resolved without all parties being served and several court hearings including a mini-trial at minimum.  Homeowners are often not even aware that their property has bogus liens left over from fraudulent non-attorney foreclosure-stopping services “sell” a small portion of the property to somebody with an ongoing bankruptcy in order to gain that BK cases’ automatic stay protection.  But years later, the liens are still there.  (In fact, “liens are forever” until cleared.)  Another land mine is tax liens, which also must be paid off before a short sale can be approved.  And all this while, the homeowner does not have legal protection against foreclosure in California until the lender APPROVES the Short Sale.  That means that the lender is free to auction off the home unless they have already approved the short sale, which of course they are in no hurry to do.

Also beware of Short Sale scams.  There are many unscrupulous hucksters looking to take advantage of and profit from homeowners in default.  Unlicensed people presenting themselves as “foreclosure consultants,” “negotiators”, “practitioners”, “processors”, “facilitators” or “coordinators” look for people in foreclosure and try to convince them that a Short Sale is their only option.  These people pocket negotiation fees and “process” bogus short sale transactions, exposing everyone involved to legal liability.  After they’ve taken your money (and money from many others), they disappear.  Often they resume business under a different name and in a different city; this cold never happen with an Attorney, who must maintain his license with the State Bar.  Remember, the law requires that ONLY a homeowner, licensed Realtor or Broker or licensed California Attorney can process a Short Sale with a bank.

As if all this isn’t bad enough, despite everybody’s best efforts, an honest and legitimate application to process a Short Sale might still fall through.  If for any reason the short sale process does fall through – say, for example, because the buyer loses patience and backs out or the lender does not approve the Short Sale – there are no protections for the homeowner, and lenders often auction the home off immediately.

So let’s “do the math.”  Entering the Short Sale process means months of stressful uncertainty, with the possibility that the home could be foreclosed at any moment and that the Short Sale might eventually fall through in the end.  And if the Short Sale does finally take place, the homeowner – who has to move out or face eviction – is likely to be hit with a tax bill, and their credit will be adversely affected for up to eight years in the future.  Foreclosures, on the other hand, offer decisive relief and only a slightly worse credit hit than a Short Sale.  In short, the Short Sale can leave the homeowner feeling like they came up short. 

However, the most important take-away from this article should be, you may well have other options.  You may be a good candidate for a Chapter 13 Bankruptcy, which means you can stay in your home.  Or if you do need to move, you can sell your property in a “Subject To Sale” Arrangement which avoids foreclosure and actually rebuilds your credit.  For information on Chapter 13 Bankruptcy, please contact Gomez & Simone Law at 885-219-3333www.gomezsimonelaw.com  For information on “Subject To Sales”, please contact Stay-Or-Go.Org at 888-892-0858www.Stay-Or-Go.Org  If you are considering a Short Sale, you have nothing to lose and everything to gain by making these calls before signing on the dotted line.  The consultations are free, and there is no obligation.

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