Short Sales and Foreclosures – Don’t Believe Everything You Hear

Most likely, you’ve been hearing quite a bit about “short sales” the last few years.  You may be asking, “What, exactly are they?”

Short sales are not new, despite not being very well known before the current state of the housing market. It is one of a homeowner’s last options for avoiding a foreclosure. When a bank approves a short sale, it agrees to accept a sale price on a property which will not pay off the total amount owed on the mortgage.

There are many misconceptions about the process, and the first thing a person should know is to be eligible for a short sale you first have to qualify!

To qualify for a short sale:

1. You must owe more on the house that what you can sell it for on the open market.
2. You must be able to prove that you have a true financial hardship, such as a job loss, or medical condition that has affected your ability to earn the same income. Other situations such as divorce, probate situations, etc…may also qualify.

So now you have an idea of what a short sale is and how it relates to avoiding a foreclosure. However, I’ve found that there are some common misconceptions about the relationship of short sales vs. foreclosures…let’s address some of the more common false beliefs.

1.) A foreclosure ends your liability and allows you to start completely over.  

This really couldn’t be further from the truth. In most states, if the foreclosure auction sale does not produce enough proceeds to pay off the mortgage in full the bank may still be able to sue you for the balance owed, known as a deficiency balance. You should check the laws in your state as the laws can vary greatly from state to state.

Believe it or not, you could also end up owing the IRS, in addition to the deficiency balance! Although the Mortgage Debt Forgiveness Act currently allows exemptions, mostly for primary residences, there are times where a tax liability is created in a short sale or a foreclosure. I know it’s hard to believe (and maybe not), but the IRS actually looks at the balance that is ‘written off’ by the bank as income to you for tax purposes! Yes, you read it correctly…you may have just lost the largest investment in your life and the IRS looks at it as a ‘gain’ on your taxes. To collect, banks and the IRS can levy accounts, garnish wages and more! A short sale will usually allow you to avoid many of these negative impacts, mainly alleviating the risk of a deficiency balance and also the IRS tax liability (as long as the Mortgage Debt Forgiveness Act remains in affect).

2.) There is no way to stop a foreclosure once the process starts. 

This one is completely false. There are more options today than there have ever been to avoid foreclosure. Although a short sale is usually the best option, loan modifications or a deed in lieu are other choices as well. Talking to a real estate professional about your situation is the best way to find guidance on which option is best for your situation.

3.) Banks prefer foreclosures more than short sales. 

No Way! A foreclosure takes a lot of time and cost banks a lot of money; short sale save banks both time and money. Additionally, banks have a huge back log of foreclosures do to the ongoing effects of the market collapse…adding to the already huge inventory of foreclosed properties is not what the banks are looking to do. As long as you qualify, many banks welcome a short sale.

 4.) There is a negative stigma associated with short sales. 

A short sale should be seen as a helpful tool, not a negative. In some subarban areas of Washington DC like Upper Marlboro, Bowie and other surrounding areas, short sales account for 25 to 50% or more of all sales. This is typical for many areas across the county and has affected consumers in all communities, and in every economic and social demographic imaginable.This is exactly why the government has made such a big push to help both consumers and institutions facing tough economic times.

5.) Short sales often get denied because they are so complicated. 

Though the short sale process is time consuming; it is not as difficult as the media would have you believe. An experienced agent can usually help you avoid many of the common pitfalls that cause banks to deny a short sale request. If you decide that a short sale is right for your situation make sure your agent is skilled and experienced in this area.

6.) I don’t have the money to have a short sale done.  

A short sale should not cost you any out of pocket money. In fact, many short sale programs now have possible financial incentives for the home owner, as long as the home was a principal residence. Even the commission that a Realtor will charge will be paid from bank proceeds. The only potential cost you could incur is if the bank requires a monetary contribution to release you from a deficiency balance in the short sale, which does happen from time to time.

7.) I can perform a short sale any time. 

Not necessarily. The farther you get behind on your payments, the harder it is to get a short sale approved. As the bank gets closer to a foreclosure sale, and the more money they pay to an attorney, the less likely they are to approve a short sale. The sooner you start the process, the better. Waiting too long can trigger the foreclosure process, causing you to lose a short sale as a viable option.

8.) I can’t do a short sale because I’ve already received a foreclosure notice. 

Just because you have received a foreclosure notice or notice of default it does not mean that a short sale is no longer an option. Some banks will even postpone a foreclosure auction to work a short sale. Of course, the closer you get to the foreclosure auction date, the fewer options you have. Do not hesitate! The closer you get to the foreclosure date the harder it becomes to negotiate with the bank

9.) If I’m denied for a loan modification, then I’ll also get denied for a short sale.  

Short sales and loan modifications are handled by two separate process of approval, and two separate departments, at the bank. Actually, in many cases you can get a short sale approved faster than a loan modification. Loan modifications are usually denied because they cannot reduce the loan low enough based on the consumers income…this is a helpful fact when asking for a short sale approval.

10.) I won’t be able to buy another house for a long time, if I do a short sale. 

Purchasing another home after a short sale really depends on how your credit looks overall. I’ve known some people to purchase in less than 12 months, although the average is about 12-24 months.

These are just a few of the false beliefs surrounding short sales and foreclosure. With the options available today, there are definite alternatives to foreclosure. Contact a local real estate professional today to determine which option is best for your situation.