Should I Consider a Short Sale?

Options for Underwater Home Owners

Should I Consider a Short Sale?
March 4, 2014

A short sale of a home is a sale where a mortgage lender accepts a price that is less than the amount that a borrower still owes on the property. In essence, it's a form of partial forgiveness of debt.

Short sales are generally considered the next-to-last resort, one step above foreclosure. In both cases, you will lose your home, but a short sale causes less damage to your credit, and you will be more readily able to qualify for future mortgages. You may have to wait up to two years in the case of a short sale, versus seven in the case of foreclosure.

A huge disadvantage of short sales (or foreclosures) is that the debt, although forgiven, is considered taxable income. However, the Mortgage Forgiveness Debt Relief Act of 2015 waives those taxes (up to $2 million) to help homeowners caught in the recent crisis, but this provision expires at the end of 2016. Thereafter, the corresponding tax bill could be huge, making a short sale impractical.

Before looking at short sale alternatives, you should evaluate how you got to this point in the first place. Is it through a catastrophic situation such as medical bills, job loss, divorce, disability, etc.? How likely are you to recover from this situation? Were you overextended and/or dealing with poor spending habits? Were you a victim of bad timing with the drop in home prices but otherwise in good financial standing?

It's important to address these questions honestly. You need a plan for improving your finances as a template for your daily life, as well as having something to present to lenders.

With that in mind, consider these alternatives to selling short:

  • Wait It Out – If you can still make payments, there's no reason to sell short. Home prices are rising in many areas, so you may reach a point when you are no longer underwater and can refinance – and if you qualify for HARP (the Home Affordable Refinance Program); you may be able to refinance anyway if you are only slightly underwater.

  • HAMP – The Home Affordable Modification Program (HAMP) is similar to HARP but is for those who can't make payments, don't qualify for refinancing, and are in more imminent danger of losing their home. The program reduces the risk for participating lenders, thus helping them to drop your total monthly mortgage costs below a typical goal of 31% of your pre-tax income. You will need to prove some form of hardship, so have all of your records available and expect them to be scrutinized.

  • Negotiate With Your Lender – Even if your lender doesn't participate in HAMP or you can't handle the 31% criteria, it's worth discussing loan terms with your lender. Offer a revised payment plan or loan modification, along with some reason to convince the lender that you can correct your situation. It's in your lender's best interests to modify your terms and eventually recover all costs, instead of writing off debt through a short sale or being stuck with a house through foreclosure. Remember, banks want your money, not your house.

The point is that a short sale may be a better choice than foreclosure, but the other options listed above are far superior to both. Be sure you exhaust all available possibilities before following the short sale path – but if that's what you have to do, make the best of the situation and develop a sound financial plan to avoid getting in this situation again.

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