Foreclosure or Bankruptcy May Be the Smarter Option
When you’re struggling with debt, you may be desperate for any kind of debt relief.
If you have a large mortgage hanging over your head, or your property’s underwater, financially speaking, one option the mortgage lender may give you is what’s known as a “short sale.”
On the surface, it may sound appealing, like a great way to get out of debt, but in most cases, it’s simply not.
What’s a Short Sale?
A short sale is an agreement between a mortgage lender and borrower to accept less than the full balance owed on the mortgage to release the lien to a new buyer. For example, if you owed $300,000 on a first mortgage but could only sell the home for $250,000, in a short sale the bank will release its lien for $250,000.
However, it’s rarely this simple.
This is because the lender typically wants you to remain liable for the deficiency (or settle it for some lump sum of cash). The deficiency is the difference between what you owe and what the property sells for in a short sale or foreclosure. In the example above, the deficiency would be $50,000.
Furthermore, for those with more than one mortgage or line of credit on their house, the short sale typically does not cover the second loan, leaving the entire second mortgage or line of credit as a deficiency once the property is sold.
Very few lenders, whether for a first or second mortgage or home equity line, waive the seller’s liability for a deficiency in a short sale.
Because of this, people who do short sales on their property often come out of the short sale with debt they cannot pay. They are out of the house and no longer paying the mortgage(s), but they are still liable for the deficiency on the first or second mortgage (or line of credit or small business loan), and they will eventually have to pay that debt or face being subjected to harsh collections actions and lawsuits.
If your debt is becoming overwhelming, and you’re unsure the smartest way out, it’s time to speak with debt settlement attorneys Wink & Wink. They’ll assess your debt situation and help you make the right choices to get out of debt in the best way possible. They may be able to help you get a waiver of the deficiency altogether, or a settlement for less than the full amount of the deficiency. It helps to negotiate this as part of the short sale.
Tax Implications After a Short Sale
If you are fortunate to get a waiver of the deficiency at a short sale, it is important to note that any debt forgiven by a credit grantor (such as a mortgage lender) is considered taxable income. That means that if you did a short sale in which the house sold for less than what you owed and the deficiency was forgiven by the creditor, that deficiency will be treated as your income for tax purposes. (This also applies to credit card debt settled for less than the full amount.) You may have a defense to this income and be able to avoid paying tax on it if you were insolvent (i.e., your liabilities exceed the value of your assets) when the deficiency was forgiven.
The Difference Between a Short Sale and a Foreclosure
A common myth is that a short sale is better for your credit than a foreclosure.
This is simply not true.
As far as FICO, Fannie Mae, and Freddie Mac are concerned, a short sale is a defaulted mortgage debt, just like a foreclosure. The Federal Housing Administration (FHA) will not allow you to take out another mortgage loan for three years regardless of whether you did a short sale or let the home go into foreclosure.
Foreclosure, as opposed to short sale, can actually offer you big benefits. This is because once you decide you can no longer afford the mortgage payments (or that you no longer want to keep paying on an underwater mortgage that will never gain back any equity), you can live in the home for free during the foreclosure process.
In most states, the foreclosure process allows you approximately five months in the house before it is sold. However, in most cases the timeline is much longer than that (and bankruptcy can stretch it even further) because lenders typically do not start the foreclosure process for three to six months or more. As a result, many people who decide to let their home go into foreclosure end up living rent free for nine to 12 months or more.
If you do a short sale, you must move out once the house is sold. You must also show the house to potential buyers, which causes a lot of stress and work. And in many cases, after all that work trying to get an offer on the house, the bank ends up dragging its feet and then declines the short sale anyway!
While foreclosure allows you to save money for the next step, it typically does not get rid of your liability from a deficiency on a first or second mortgage or line of credit. For that you need bankruptcy.
Bankruptcy and foreclosure sound like scary words. But they can actually be a smart, sensible way to break free of crushing debt. If you’re in need of debt settlement, the first step is speaking to a skilled bankruptcy attorney, such as Denver’s Wink & Wink. They’ll review your case and see if foreclosure and bankruptcy make the most sense for you.
Short Sales and Bankruptcy
The bottom line is that most people considering a short sale or foreclosure have more debt than they can pay. Many people have been trying to keep up with increasing mortgage payments, dealing with wage reductions or job loss, or have significant medical bills they cannot pay. A short sale or foreclosure typically does nothing to get rid of that additional debt.
Most people considering a short sale feel that it is somehow “the right thing to do.” However, the only people benefitting from the short sale may be the realtors who make a commission. It may not help the seller at all. In most cases, the seller is left with a deficiency, has to leave a house they could have lived in much longer for free, and still has a deficiency liability from the home as well as all the credit card debt and medical bills to contend with.
This is why bankruptcy and foreclosure often go hand-in-hand. Bankruptcy wipes out credit card debt, medical bills, deficiencies on foreclosures and short sales, and deficiencies on repossessions too.
Bankruptcy gives you the greatest debt relief available under the law and, when used in conjunction with a foreclosure, can position you to get a fresh start in the strongest position possible for you and your family. Bankruptcy can even stop a foreclosure in its tracks and give you additional time in the house while you get yourself ready for the next step.
If you are struggling with an underwater home and any other type of debt that you cannot pay, get the facts from a bankruptcy lawyer, such as Colorado-based Wink & Wink, and find out what makes the best sense for you, not the mortgage lender. Give Wink & Wink a call at 303-410-1720, or contact us online today.