With a majority of sellers in my local markets of Avondale, Goodyear, Glendale, Litchfield Park, and Surprise, Arizona "upside down", this is a question I am often asked. There really is only one answer for families in this situation...a "short sale."
A short sale is an agreement where the lender on the property agrees to accept less than the full balance owed on the mortgage. Short sales are complex transactions that typically take 4-8 weeks to complete and require an experienced (and persistent) Realtor to manage. I have previously written several blogs about how to complete short sales which can be read here: Short Sale Blog
Why should homeowners consider a short sale?
There are a number of reasons to consider a short sale. For example, if you need to sell as the result of a job relocation and cannot afford negative rents on your property, a short sale would be the preferred option. Many homeowners in my local area are stationed at Luke Air Force base in Glendale, AZ and have been forced into doing short sales when they are transferred to another base. Another reason to do a short sale is to save your personal credit. In the past 12-18 months many homeowners have found themselves in the unenviable position of not being able to afford their home due to a job loss, rate adjustment or family emergency. In a normal market, many of these families would be able to refinance or sell their property. But today, the only sensible option is to sell through a short sale.
Is a short sale right for you?
Every homeowner's situation is unique and there is no one right answer to this question. When counseling homeowners I generally focus on 3 key questions:
- Why do you need to sell? If you don't absolutely need to sell then a short sale should be the last option considered.
- Are there other options available to you? I generally recommend homeowners consider other options before resorting to a short sale. Refinancing, loan modification and renting the property are generally preferred options to a short sale.
- What do you plan to do after the short sale is completed? Homeowners need to consider the consequences of a short sale and plan for their future housing needs.
What are the impacts of a short sale?
There are 3 consequences every home seller should evaluate before making the decision to apply for a short sale.
- What is the impact to your credit rating? Short sales generally appear on a credit report similar to a large charge off. I have seen several that appear with the unusual phrasing "Debt Paid in Full Less Than the Full Amount." It has been my experience that by themselves, short sales generally lower credit scores by 50-100 points. If a homeowner is able to keep their payments current up until the home is sold, they suffer very little in terms of derogatory credit when completing a short sale. For those homeowners who become delinquent on their mortgage, the credit score will be more adversely affected by the late payments than they will by the short sale. Regardless, a short sale on a credit report is substantially better than a foreclosure (or deed in lieu) and allows the home seller to be able to qualify for new mortgage financing in a much shorter period of time. The current minimum waiting period after a foreclosure is 4 years for Fannie Mae & Freddie Mac. Homeowners who are able to maintain a perfect mortgage payment history through a short sale may be able to qualify for a mortgage after only 1 year. And finally, please know that you do not need to be behind on your mortgage payments to qualify for a short sale. I have seen many short sales approved where the homeowner is able to make payments throughout the short sale process. There does, however, need to be a pressing "hardship" for the bank to consider accepting a short payoff.
- Is there a potential that the unpaid debt could remain as a consumer loan? This is particularly a concern where the homeowner has a 2nd or "piggy back" mortgage on the property. Many 2nd mortgages, especially home equity lines of credit, contain provisions that allow the note holder to convert any unpaid mortgage balance into a consumer debt. It is also fairly common for banks to request that a consumer assume some form of future liability as a condition for approving a short sale. As I mentioned before, every homeowner's situation is unique and each seller should evaluate these options individually. But it has been my experience that it rarely makes sense for consumers to accept any deficiency debt to be applied to their personal credit; particularly in states like Arizona which normally prohibits deficiency judgments on owner occupied 1-4 unit residential property.
- What are the tax consequences? The good news is that the federal government recently created new tax exemptions for homeowners who complete short sales. Generally speaking, homeowners who occupied their properties and did not withdraw substantial equity from their home are eligible. However, it is always advisable that you consult a licensed CPA/Tax Accountant to determine what your potential tax consequences will be before proceeding with a short sale. You don't want to find out months later that you have a $25,000 capital gains tax bill from your short sale.
Short sales are complicated transactions but can be the best option for struggling homeowners. I hope these comments have assisted those who are considering a short sale.
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