You’re thinking about selling your home, and you know it’s worth less than the amount you owe. You’ve heard from many people who have done it that you can simply get out of your house free and clear with no repercussions or financial consequence. You’re tempted to move forward, but you’re just not sure whether or not you should.
Some people are in a financial position that gives them no option but to move forward. Others could fulfill their obligation over time. One of the questions everyone is asking is whether or not they’ll be liable for the difference if their bank forgives them of the debt above and beyond what they can bring at sale.
This can all get a bit confusing, and there are many circumstances involved, but before I continue, I must make clear to you that some of these questions need the advice of an attorney and/or CPA, of which I am neither, and I don’t claim to know anything about the law. What I do know is what I’ve seen happen on others’ lives.
There is no simple answer, but let’s do some math and explain some of the potential consequences. Let’s make it simple. You owe $100,000.00 on a house that’s worth $80,000.00. You put it on the market, and find a buyer who is willing to pay your list price of $80,000.00. The bank agrees to the sale, and receives a net payment at close of escrow for $80,000 minus closing costs and broker commissions. For the sake of ease, let’s round it out to $5,000.
So you’ve managed to sell your home and bring a net payment of $75,000 to your lender leaving an outstanding balance of $25,000 on the original loan.
Potential Scenarios
These are some of the potential scenarios that you’ll face in the future, depending upon the conditions of your original purchase of the home, and the conditions on your lender’s agreement to sell short:
(note: In ALL cases, debt forgiveness or “cancelation” is taking place, which according to the IRS becomes reportable income [not necessarily taxable] to you.)
- Your lender agrees to release the lien AND forgive you of the balance in full. They report “Paid in full for less than the amount owed” or something of that nature on your credit report, and send you a 1099-C for $25,000.00.
- Your lender agrees to release the lien and leaves out any agreement to forgive the difference. The note remains, and you continue to pay it down until it’s satisfied.
- Your lender agrees to release the lien and leaves out any agreement to forgive the difference, requiring you sign a promissory note for the amount owed and you pay it down over time.
These are a few of the possible scenarios on a single loan. If there are multiple loans on the property, then you’ll have varying combinations of potential outcomes. It’s key that you understand that there are 3 different issues that most people consider when going through a short sale:
a) are you liable for the difference.
b) will the debt cancellation become taxable income.
c) how will your debt history be affected (I loathe the term credit.)
Are You Liable for the Difference
I don’t know. You need to talk with an attorney to determine whether or not your lender will win if they pursue you in a lawsuit for the difference. The easy answer is, be prepared for it, cause it’s possible, even in a state with Anti-Deficiency Statutes like Arizona.
Will the Debt Cancellation become Taxable Income?
Maybe. It’s possible. But you also may be able to write it off in accordance with the Tax Relief Act of 2007. Consult your CPA.
How Will Your Debt History (Credit History) be Affected?
Let’s be real about this. Nobody in any financial sector has come to an agreement upon the standards regarding credit reporting. Everyone has their own opinion about how much it will be affected and how long it takes to heal. If you’re concerned about your credit report, consider studying a bit more about what it really means to your life, building wealth, and the future of your family’s financial tree. Credit does not define you.
