First of all, What is a Short Sale?
The legal definition of a short sale (a house) is the sale of a home where the proceeds are insufficient for what the owner still owes on the mortgage. In layman’s terms, that is when your lender agrees to accept less money for your home than you currently have to cover the mortgage.
Many lenders will agree to accept the proceeds from the short sale and forgive the remainder of the loan when the owner is unable to make mortgage payments and can prove trouble. Why? Because by accepting short sales, lenders avoid the lengthy and expensive foreclosure process. For lenders, there are many costs associated with a Foreclosure lawsuit, including attorney fees, property damage, and property maintenance, and if the property is auctioned, they can lose even more.
When a lender approves a short sale, the homeowner gets the opportunity to avoid or minimize the damaging effects of a mortgage foreclosure lawsuit.
What’s Bad About Foreclosures?
If your situation gets to the point of foreclosure, the lender will take your home and eventually sell or auction the home, using the proceeds to pay off the loan. If the foreclosed collateral is sold for less than the remaining balance on the main mortgage loan, the lender has the opportunity to file a Shortage Judgment against you. Judgment can be used to place a lien on your property or other assets that requires you to pay the difference. Because you are responsible for every penny lost from the lender and all fees added to the shortfall assessment, your debt could end up being much larger than you expected. Shortage Judgment will destroy your credit and follow you for the rest of your life until you pay it off.
Prior to the Mortgage Forgiveness Debt Forgiveness Act of 2007, if the value of your home declined and your lender pardoned part of your mortgage, the tax code treated the amount forgiven as income, and was therefore taxed. Thanks to the 2007 Act, however, there is now a three-year window for homeowners to refinance their mortgages and pay no taxes on the debt forgiveness they receive. However, there is a limit to this forgiveness. This only applies to mortgage debt issued by the lender in 2007, 2008 or 2009, and only to loans granted to purchase or build a primary residence. For additional properties, you may still be taxed on debt cancellations. (For a more in-depth discussion of the Mortgage Forgiveness Debt Relief Act 2007 and debt cancellation, visit http://www.irs.gov/individuals/article/0,,id=179414,00.html
To be sure, foreclosure is complex and far-reaching, with implications that go far beyond losing your home today. Be sure to seek professional legal and tax advice before making a decision to proceed with foreclosure to ensure you fully understand all the negative implications foreclosure may have on you personally, today and both for your future and for your family.
How They Affect My Credit
Often you will hear claims that Short Selling can save your credit, but what does it really mean? Both short sales and foreclosures will result in about a 200-300 drop in your credit score, or FICO, so both will have a negative impact on your ability to get credit in the future. The amount of time it takes for your credit score to recover from a short sale, however, is generally less than the time it takes for your credit score to recover from a foreclosure. And with a short sale, you will likely be able to buy another home within two years during the three to five year period required for foreclosure.
Simply put, it is in your best interest to do everything you can before a foreclosure occurs, and to do so as quickly as possible before your options become more limited.