A short sale is often the best available option for individuals who need to sell their home but owe more than they can receive in a sale – this is often referred to as being “upside down” on a loan. In many cases, by working properly with the lender, that lender will agree to write-down the loan to a level that will allow a standard market sale. Because the lender is performing a write-down instead of the seller bringing sufficient funds to close the loan at its existing level, it is considered “selling short”, hence the reference of “short sale”. While this can be a great alternative, do not be fooled, the process is anything but “short”!
Why Conduct A Short Sale?
There are three main reasons to conduct a short sale:
The first being the protection of your credit record. While FICO states that they rate a short sale and a foreclosure the same, that is only for the event itself. Keep in mind that there is a “foreclosure” mark on credit records, but there is no “short sale” mark. If the bank does not foreclose quickly, every missed payment registers as an additional “hit” on your credit record above and beyond the actual event itself. In addition, many employers ask on their application if an individual has a foreclosure in their past.
Depending on the situation a foreclosure can prevent the Borrower from obtaining another home loan for 2 – 7 years, depending on situation, while a short sale registers as 2 years in many cases. Most short sales are reported on a credit record with language similar to “debt settled for less than amount owed”.
Second, not only is it important that it shows the debt positively settled, it is much easier to explain on future credit applications when the individual obviously worked with their creditor to alleviate the situation rather than just walking away. With mortgage underwriting standards constantly changing, addressing your distressed situation with a short sale rather than ignoring it and allowing the foreclosure could play to your favor under future standards.
The third important reason to conduct a short sale is to avoid a deficiency judgment. In this situation, the creditor can legally pursue the debtor for several years after the debt is closed, continually delaying the recovery of a credit record and potentially ending with the wages of the debtor being garnished when the process is complete. For example, if a homeowner owes $500,000 on their home and the sale only nets $400,000, they would be “deficient” $100,000. California is a “single action” state where in most cases a lender can only foreclose or pursue a judgment, but not both. However, that is only for the foreclosing entity and does not cover other debtors on the same property like second loans. Also, the sale value of the home could be well under market if the home is sold at auction or remarketed several months later as a bank-owned property, creating a much higher deficiency balance. This is a complex issue, but with the passage of SB 458 on July 11, 2011, all approved short sales are now final for any mortgage lien holder. That is not the case if the home is foreclosed. Unless the second loan was taken at the time of purchase and not a re-finance, a foreclosure will in most cases allow the second lien holder to still pursue a court judgement. As a result, it often makes sense to pursue the short sale and eliminate any possibility of a deficiency judgement by the second lien holder.
Why Do Lenders Approve Short Sales?
There are many “approved” instances in which lenders would agree to allow the homeowner to short sell their home, including job loss, relocation, divorce, deteriorating health, large mortgage reset, and other financial difficulty. However, the simple fact is that a foreclosure typically costs a lender between $30,000 and $70,000 in lost income, legal, and remarketing fees. While unadvisable and illegal, many homeowners will gut or severely damage a home before leaving, significantly lowering the resale value of the home. In addition, a vacant home is a prime target for vandalism and theft. In a declining market the value of the home goes down every day and a foreclosure can take much longer to bring to market than a home already prepared for sale. In the end, any home obviously headed to foreclosure will put pressure on the lender to allow the short sale rather than face the higher expense and risk associated with a foreclosure.