Short Sale Pros and Cons – Introduction
Last week, I discussed how it is possible to sell your house fast through a short sale. This week I’m taking a look at short sale pros and cons that you need to take into account before taking this exit. As a disclaimer, I am not a lawyer and none of the following should be taken as legal advice. If you want legal advice and live in Virginia Beach, Norfolk or Chesapeake, I suggest getting in touch with my real estate attorney, Consolvo, Markowitz & Webb. Each state has it’s own set of laws and Virginia’s foreclosure laws may be very different than those of your home state. Lastly, this list is not comprehensive, but contains the main questions have I have encountered while helping other home sellers facing foreclosure.
Deficiency Balance – You May Still be on the Hook
First and most important, just because your lender approves your short does not necessarily mean they will forgive the debt. This debt is called a deficiency balance. In Virginia, the deficiency balance can stay in effect up to twenty years. Sounds like bad news, I know. But bare in mind this is a worst-case scenario. Generally, first position lenders forgive the shortfall by negotiating a waiver of deficiency. When you decide to short sale your house with me, I will help you negotiate this release and we will only move forward once we’ve secured it. If there is a second position lien holder, securing this release can be more difficult.
Multiple Liens Can Prolong the Process
To be brutally honest, if you have multiple liens on your property, it will be very difficult to sell your house fast. Here’s why: in a short sale, the second position lender generally receives a much smaller piece of the pie than the slice the first position lender receives. The second lender will want to receive multiple offers from in hopes of minimizing their losses. This process takes a very long time. Second position lenders are also much less likely to agree to a waiver of deficiency. Clearly this is bad news, but there is no way of getting around it besides declaring bankruptcy.
Tax Implications on “Phantom Income”
According to the IRS code, the forgiven debt is considered “phantom income” and is taxable. Thankfully, in 2007, The Mortgage Forgiveness Debt Relief Act was passed. This bill relieved sellers of the phantom income tax burden on the sale of their principal residence. To be considered a principal residence, you must have lived in the property for two of the last five years. It’s important to note, that this exemption does not apply to income properties. Although this makes the sale more challenging, a knowledgeable accountant can really help you minimize the liability.
Here’s a short but funny story about the first time I helped out a Norfolk home owner with a short sale. We had a meeting with my accountant in the hopes of minimizing the seller’s tax liability. My accountant kept talking about cod. I’m thing why are you mentioning fish? Turns out, it wasn’t cod, but C.O.D., or the IRS’s technical term for Cancellation of Debt. When you sell your house to me, I can help you out with this as well.
One caveat: this act is set to expire at the end of 2014; although, Congress will very likely renew the bill.
Credit Score Impact
Make no mistake; a short sale is going to ding your credit in a very big way. There’s no getting around that. Here’s the good news, according to the website NOLO.com – Law for All, “With the average short-sale, the former-homeowner is more likely to be in a position to stay current on accounts and decrease credit card debt. In fact, many people who go through short-sale see improvement to their FICO scores in just two years.” NOLO also asserts that the credit hit for a short sale is not as bad as that for foreclosure. One more reason to not “just walk away.”
Waiting Period Before Being Able to Purchase a New Home
With a short sale on your record, there is a very good chance that you will not be able to obtain a federally backed mortgage for at least two years. That’s a long time, but it’s much better than seven year restriction that results from foreclosure. Besides the general mortgage restrictions, you’re your credit score is going to make obtaining a new mortgage difficult. But don’t despair; mortgage loan officers have programs designed to rebuild your credit. If you live in Virginia Beach, I recommend working with Gerard Golden at BB&T.
Short Sale Pros and Cons – Conclusion
A short sale can have some pretty nasty side effects, but the alternative of letting your house fall into foreclosure is far worse. Besides the ethical implications of “just walking away” from an obligation, your credit, your tax burden and your chances or receiving waiver of deficiency are all much more severe with foreclosure. Also, with a short sale, you retain more control of the process and it sure is preferable to having the sheriff post an eviction notice on your front door. Most importantly, you will have a greater sense of dignity knowing that you sold your home rather than having the bank take it away. If you are interested, in selling your Virginia Beach, Norfolk or Chesapeake home to me via a short sale, I will do my best to guide you through the process.