When you consider the fact that whether or not you are able to sell your home before the bank forecloses, the bank will eventually foreclose if you don’t pay your mortgage, it would be beneficial to you to at least attempt to sell the home before that happens.
It’s really not Foreclosure vs. Short Sale
There’s no competition here. There’s no “one way is the right way” scenario. The bottom line is, once a homeowner stops paying their mortgage, they are headed for foreclosure. A short sale can be conducted at any time prior to foreclosure. You do NOT have to be behind on your mortgage payment for a competent real estate agent to negotiate with the bank to allow you to sell your home for less than you owe. If you are headed for foreclosure, there’s absolutely NO disadvantage to attempting a short sale. In fact, there is a benefit.
Banks Pay Big Bucks to Foreclose
That’s right. When the bank reposesses your home, they spend money to do so. The hire attorneys to handle mountains of paperwork and they have costs associated with conducting a trustee sale. Then, when all is said and done, they have to hire a real estate broker to list the home for sale, which will cost them additional fees.
Who Makes Up The Difference
Let’s say you purchased your home for $150,000 and over a year’s time it increased in value to $200,000 and you decided to take out a $50,000 equity loan based on the current value. The market values fall and now you find that the house is worth $160,000 and you’re upside down by $40,000.00. You fall on hard times and can no longer afford payments on your combined mortgages of $200,000.
When you owe $200,000 on your home, and the bank forecloses and sells the home for $160,000 it is you who are responsible for the difference. Since Arizona is a non-deficiency state, the bank will probably write it off. However, and keep in mind that I am not a tax expert, if the $50,000 you pulled out of your house was not used to invest in that house, and instead it was used to invest in something else, like another house, or a vacation, or a car, then you’re in a sticky situation. The bank may come after you, because that loan was probably tied to you with a personal guarantee.
Whenever a bank writes off a deficiency from a foreclosure or a short sale, they issue a 1099-C so they can show the IRS that they have a loss. This 1099-C is an income statement for you and it must be reported to the IRS. If your financial situation meets certain criteria, then you may be able to deduct that same amount from your tax return and thus not owe any taxes on it. If, however, you do NOT qualify, you may find yourself paying income tax on the deficiency. So it would make sense to reduce the liability as much as possible.
Sell It Short
The best way to reduce your potential liability is to give your local real estate expert an opportunity to sell your property BEFORE it forecloses. Look, the property is headed for foreclosure anyway. The banks know that it costs them a fortune to reposess homes and sell them at auction, so they are much more likely in economic times such as these, to allow you to sell it BEFORE they incur those expenses. Rather than pay the attorneys, the bank agrees to pay the real estate expert, and saves a bunch of money. Bank owned properties sell for less than properties that are selling short, and that translates to a smaller deficiency, and less reported income, saving you potential tax dollars.
Don’t simply walk away without giving your local real estate expert the opportunity to help both you and the bank save some money. And guess what, it helps them out too, because that’s how they feed their families.
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If you know you are heading into foreclosure, you certainly don’t have anything to lose by trying to short sale your home. One thing people need to keep in mind when buying a short sale is that the process takes a lot longer than a normal listing. Patience is indeed a virtue.
Charles, that’s the absolute truth. In fact, selling short isn’t just loss mitigation for the bank, it’s loss mitigation for the potential tax liability or deficiency judgment against the homeowner, depending upon their tax and state laws.
Ah, I never understood the difference between the two before. Thanks for sharing, it was a great and informative post.
Any time Max. Thanks for the comment.
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If I were going under I would try my hardest to short sale. The bank or lender isn’t going to put in the effort to sell your home for top dollar. They know in the end that you will still be responsible for the difference between selling price and amount owed.
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