Thursday, June 27, 2013

What's a Short Sale? What's a Foreclosure? What Should You Do?

The number of short sale (sometimes called (pre-foreclosure) homes and foreclosures may have diminished from a few years ago, but they haven't gone away. If you're underwater and just suffered job loss or some kind of financial emergency--usually a medical one--you know how real the situation is.

A short sale results when a home sells for less than the underlying debt and closing costs. For example, a home once worth $300,000 and has a mortgage for $280,000, but only sells for $250,000 on today's market. Reduce that by $15,000 for broker commissions and other sales costs, and it leaves $235,000 for the lender. The lender is therefore "short" $45,000.

Of course, there can be, and usually is, more than one loan. Other debt, such as past-due HOA assessments, property taxes, mechanic's liens, judgments and the like may also be on the home. With defaulting borrowers, when it rains, it really does pour.

A foreclosure occurs when the lender sends you a formal Notice of Default and waits the required number of days before taking your house. That's a non-judicial foreclosure, by the way, which means no judge is involved. Lenders can also go to court and sue. That's called a judicial foreclosure.

When a borrower simply gives the deed to the house back to the lender instead of goiung through the foreclosure process, that's called a deed-in-lieu of foreclosure (DIL).

If you're faced with financial catastrophe and can't pay your mortgage, what should you do? In general, a short sale is better for most people. If your home is HAFA eligible, you may even get up to $2,500 in relocation assistance. And Freddie Mac and Fannie Mae both say a borrower will be mortgage-eligible two years following the date of the short sale.

The credit score recovery time from a foreclosure (or DIL) is longer. Moreover, don't forget that little box on the mortgage application that says, "Have you had a foreclosure within the last ten years?"Also, you won't be able to buy another home for five to seven years.

It's hard to say for sure what happens to your credit score. FICO says either a foreclosure or short sale will ding your credit score by as much as 160 points, and makes no distinction between the two. At least that much will happen, and probably more, since all the unpaid mortgage payments have been stacking up.

One downside to short sales is a deficiency judgment. A deficiency is the amount the lender agrees to forego in the sale. Some lenders in some states will sue for the deficiency and likely win. Down the road sometime, the borrower will find the deficiency amount has to be paid, often with accrued interest.  Usually, though, a lender will forgive the amount of debt, especially on the first mortgage. The wording will have to be in the short sale agreement, and a lawyer really should look over the paperwork. It's also important to have a broker who's competent (not necessarily "experienced") in short sales and has a negotiator on staff or retainer.

The forgiven debt is probably taxable at both the state and federal level. As for the second mortgage, negotiate the amount down as much as possible--go for ten cents on the dollar--and sign a promissory note for it, if you can.

People with extreme financial hardships may want to consider foreclosure. If the financial future is looking really, really bleak, foreclosure might be a necessary option.

First, if you find yourself in straits this dire, your credit is already shot, so the relative benefit of a short sale isn't there. Second, you have to have a place to live. While it doesn't have to, the foreclosure process can take months, even years. You'll have a roof over your head. Many say that doing so is taking advantage of the system. At the same time, though, the foreclosure statutes are there to describe what happens in the event borrowers don't pay. You're not breaking any laws, and the process may give you some needed recovery time.