You should know this before you do a short sale

A short sale should be your last resort, there are better options.

A short sale, a relatively new term for a lot of people. And if you haven’t heard the term, I would guess that you live in an area that has not been greatly affected by the housing bubble. All over the country, people live in homes that are worth less than what they owe on it (sometimes referred to as being upside down or under water or having negative equity).

When a homeowner is upside down, the only way that they will be able to sell the home is if they do a short sale. In a short sale, the bank agrees to discount a loan balance because of an economic or financial hardship on the part of the borrower. Typically, a lender will not agree to a short sale if the homeowner is current on their mortgage payment.  Short sales are the last resort for homeowners to avoid foreclosure.  Just because the homeowner is avoiding foreclosure by doing a short sale, don’t think that homeowner is going to turn around and buy another home afterwards.  A short sale looks better on a person’s credit than a foreclosure; however, a short sale will report on credit that the mortgage balance was paid off for less than the amount owed.  In addition, by the time the short sale goes through, the homeowner will have late mortgage payments that negatively reflect on their credit report.  Still better than the alternative of foreclosure, which will keep the homeowner from mortgaging another home for at least four years. Moreover, various states allow the banks to file deficiency judgments for the difference in what was owed on the home loan and what the home was sold for in a short sale, which could ultimately result in wage garnishments and other actions down the road.

Both parties have to consent to a short sale and typically will when the only other choice is foreclosure which involves high fees for the bank and poor credit outcomes for the borrowers. Short sales come down to this: Is it more profitable for the lender to foreclose or do a short sale.  While losses can vary widely from foreclosures, several independent studies find them to be generally quite significant: over $50,000 per foreclosed home[1].  It is easy to see why foreclosure is the last resort for a lender.

Before deciding on a doing a short sale, people should first think about where they are going to live when their home is sold. After doing a short sale, a homeowner’s credit will be poor so they will have to rent unless they have cash to purchase a home.  Many landlords will check credit and see that their credit is poor and it is at their discretion if they want to rent to a person who has a history of not paying their obligations.

There is a new trend in short sales and that is coming from people who can afford their mortgage payments but are upset that their home is now upside down; in addition, these people think that their home values will never appreciate to where their loan balance is so they no longer want to keep their homes. People in many circumstances do not have a hardship and can afford to make their mortgage payments but choose not to because of a monetary benefit that can be achieved by doing a short sale. Many lenders are cracking down on this mortgage fraud and prosecuting their victims which are usually homeowners and realtors.  Many realtors have embraced the short sale and use it as a tool to increase their business.

One last thought that homeowners should consider before attempting a short sale:  a cancellation of debt 1099-C form will be sent to the homeowner from their lender after the short sale. This cancellation of debt amount is for the difference between the outstanding balance on the old loan and the sales price of the home.  This canceled debt will be taxed as ordinary income and add a significant amount of money to anyone’s taxes.  In some areas of the country, it is not uncommon for a homeowner to have a $200,000 mortgage balance and that same home can sell as a short sale for half that amount.  In that case, the homeowner will be responsible for a cancelation of debt in the amount of $100,000.  The $100,000 in extra income will amount to additional taxes of $21,616 in 2011 for a single person.  When your income is $100,000 for the year that puts you in the 28% tax bracket which is where the remaining income that you have will start being taxed and go up from there.  Most people don’t have $20,000 laying around to pay taxes and it would be advisable for  them to figure out where that money will come from before doing a short sale.

2011 Tax Rate Single
10% Up to $8,500
15% $8,501 – $34,500
25% $34,501 – $83,600
28% $83,601 – $174,400
33% $174,401 – $379,150
35% Over $379,150

Before a homeowner does a short sale, it is in their best interest to try to get a loan modification. Ask yourself this before deciding on a short sale:  If my mortgage payment was cut in half, would I still want to do a short sale?  Many people who are getting loan modifications are able to get a new mortgage payment that is half of their original mortgage payment.  When your mortgage is cut in half, your upside down home might be worth keeping.

This article is the fifth of a Do-It-Yourself approach to home loan modifications. Check back often or subscribe to this site to stay tuned for the next article in this series (a new post will come out each week day for a month), designed to help you complete a loan modification on your own, cutting out the middle man, helping you protect your ability to stay in your home for the best price possible, and helping you lower your payments as much as possible. After all, nobody will look out for you as well as you can look out for yourself.

  1. 1.  Desiree Hatcher, “Foreclosure Alternatives: A Case for Preserving Homeownership,” Profitwise News and Views (a publication of
  2. the Federal Reserve Bank of Chicago) (February 2006), p. 2 (citing a GMAC-RFC estimate) (http://www.chicagofed.org/community_
  3. development/files/02_2006_foreclosure_alt.pdf). See also Congressional Budget Office (CBO), “Policy Options for the Housing and
  4. Financial Markets,” (April 2008), p. 17.

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2 Comment

  1. Judith says:

    This statement in the article about a loan mod. cutting their payment in 1/2 in unfortunately NOT TRUE. They may reduce it by a few hundred and that is ONLY if you can get them to actually respond to your calls and requests. Citi Mortgage was THE WORST. I managed to get them to modify my loan after 18 months of fighting them. They only reduced my pmt. by 200.- a month. I would hate to see you mis-lead and therefore upset your avid readers, by un-intentionally giving incorrect information.

    Thank you for listening.

    Judith

  2. Results vary, and you are correct that a 50% reduction will not happen every time. Here’s a calculator to figure it out for yourself provided by the US government. I’ve seen a friend get his lowered by 75%. It all depends on the bank and the market and the amount of money you make. Thanks for your comment.

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