I have written about short sales and other owner options when avoiding foreclosure in the past. In this article, I will discuss the pros and cons for each of the options to the countless “underwater” homeowners in foreclosure throughout our country. Should you modify your loan with your lender; sell your house as a “short sale” with the lenders approval; or walk away and allow the lender to foreclose? (You may also do a Deed in Lieu of Foreclosure.)
Modify Your Loan
Ideally, you want to stay in your home if you can afford it and it makes financial sense. The big question is, “can you? and “does it?” To begin, you should ask your lender. It’s hard to say how willing your lender will be to modify your loan, until you ask. There is a lot involved in this process as your lender is going to want to completely review your financial picture with tax returns, pay stubs, financial statement, bank statements and a letter explaining your hardship. Most homeowners fall short here and don’t take the time to put this information together, simply giving up. That is not good.
If you have a government backed loan and want to modify your personal residence, you have a better chance of a successful modification falling under the “Making Home Affordable” plan. Conventional, jumbo and subprime loans do not fall under this plan and each lender will have their own terms for modification (some lenders are good and some are horrible). In most good lender situations, the lenders will offer a reduced payment and/or interest rate for a short period of time, until you get back on your feet.
However, if your principal balance greatly exceeds the market value, and you request a reduction of that loan balance as a part of your loan modification, don’t expect to the lender to agree. As much as our politicians and press like to discuss how lenders are writing down loans to help people stay in their homes, I haven’t seen or heard of one write down to date. If you have, please let me know which lender is approving principal write-downs and I will share this in my blog.
The “pro” to a loan modification is you get a reduced mortgage payment. The “con” is that even after the modification, you still not be able to afford the home and it may not make financial sense to stay in the home. If that’s the case, it’s time to make the decision to sell. You can sell voluntarily through a short sale, or you can sell involuntarily through losing the house to foreclosure. Either way, it’s time to cut your losses, downsize and move on.
Short Sale
Through a short sale the lender agrees to accept less than the balance owed on the mortgage at sale. On purchase money loans, the deficiency balance is forgiven, typically. Some of my clients have reported that some mortgage companies are asking borrowers to agree to accept liability for the deficiency balance. Don’t’ assume anything. Make sure you review your original Deed of Trust carefully (get legal and tax advice) and make certain you understand whether the deficiency balance is forgiven.
Currently, short sales are being approved in record numbers and in half the time because lenders do not want to own a distressed property they may have trouble selling later as an REO. Banks would much rather see the homeowner sell the property under a short sale, and lose the deficiency balance, than be forced to take the property through foreclosure, and take on more costs and market risks.
To successfully sell your home under a short sale, you must hire a professional Realtor. This is not the time to do a “for sale by owner.” You must make sure you go into escrow with the right buyer who will hang in there while you wade through the maze of lender requirements. There is a ton of paperwork again (tax returns, pay stubs, financial statement, bank statements and a letter explaining your hardship), calls to postpone your auction (don’t assume the lender will do this automatically), BPOs (brokers price opinion), lender appraisal, buyer contingencies, HUD1 statements, short sale approval letters, clear title and a lot of follow-up calls and emails. Oftentimes the lender will counter your buyers offer, so your buyer must have “wiggle room” in their price, ready to go up if the lender asks. A short sale is not for the weak at heart and takes a lot of tenacity and persistence.
The biggest “pro” to a short sale is the lender approves a significant write-down of the mortgage balance in exchange for cash from a new buyer. The homeowner is in control of the sale, not the bank. You will spare yourself the social stigma of the “foreclosure” word. Your credit is much less impacted than with a foreclosure. A short sale may be considered to be a derogatory mark on your credit even though credit bureaus do not show the word “short sale” on your credit report. It may say “paid in full for less than agreed” or “settled for less,” among other categories. Some clients have reported negative FICO score drops from 50 points to 130 points.
You may qualify to buy another home with a Fannie Mae-backed mortgage within two years, regardless of whether the home is your primary residence (FHA wait is 3 years). The lender has removed a non-performing asset from its books. And the buyer got a home that was cared for by a willing homeowner through close of escrow (versus a stripped home after foreclosure auction).
Outside of being a pain in the “you know what” (and complete time suck), another important “con” about short sales is the lender is required to file a 1099C if the debt forgiven exceeds $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. (See the IRS document “The Mortgage Forgiveness Debt Relief Act and Debt Cancellation.”)
Walk Away – Let the Lender Foreclose
If the lender will not approve your short sale, foreclosure is the last option, although it presents major problems. The only “pro” to losing your house to foreclosure, is that it is the easiest of the three options to underwater homeowners. You stay in the house as long as you can rent free, you don’t have to clean up the house and open your door to buyers. You do nothing, and then move. So, foreclosure is the path of least resistance.
One big “con” to foreclosure is the hit to your credit and future borrowing ability. A number of sources have reported FICO score drops from 200 to 400 points after a foreclosure. Generally this credit score will remain on your credit report as a public record for 7 to 10 years. Best case, you may be eligible to buy another home in 5 years if the home was your primary residence. Without restrictions, the wait is 7 years. If you are an investor and do not occupy the home, the wait to buy with a Fannie Mae insured loan is 7 years.
Another big “con” to foreclosure, is the auction tends to bring significantly less money than a normal sale. 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.
Make sure you consult with an attorney experienced in tax and bankruptcy law to understand all of your options to resolving your mortgage debt.
If you are upside down in your mortgage, and do not see a way out anytime soon, it’s time to take action. Losing your home to foreclosure has serious consequences. Don’t make the wrong decision. Call your lender and either work out a loan modification you can afford, or find a great short sale Realtor and get your house sold (with the lenders approval of course). But it’s time to cut your losses and move onto your fresh start. Loan modifications and short sales are legal, ethical and the right thing to do for you and your family.
I hope this column helps you make the right decision for your situation.
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By Lorena Tankersley SFR, CHRE. Lorena is Listing and short sale specialist with Keller Williams and president of the Women Investment Group (WIG). You can find her at www.WomenInvestmentGroup.com
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