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Is a short sale a better alternative than losing your home in a foreclosure?

A “short sale” is term that refers to a sale of real property where the sales price, after the expenses of the sale are deducted, is lower than the amount owed on the property by virtue of mortgages, and other liens. A short sale is only possible if the lenders and/or lienholders with respect to the property, agree to accept an amount lower than what is actually owed on the debt.

In a typical short sale scenario, the homeowner initiates the transaction by accepting an offer from a buyer and then having a Contract of Sale prepared and signed by all parties. A good contract will state that the sale is subject to the approval of any creditors with liens or interests in the property, including, their approval of the sale price, which could be below the appraised value of the property. In order to approve the short sale, the creditors will ordinarily request a copy of the contract of sale, demonstrating the sales price, an appraisal or broker’s analysis demonstrating the property value, a broker’s listing agreement stating the broker’s commission to be paid (if any), and a proposed settlement statement showing the closing costs associated with the sale. They may also request tax returns, bank statements, and financial information from the homeowner, to demonstrate a  financial hardship, and inability to pay the entire amount owed.

To qualify for a customary short sale, the Seller and the property must meet certain requirements such as: the net proceeds from the sale must be lower than the remaining balance on the mortgage (net proceeds simply is the sale price less all closing costs [e.g. legal fees, transfer taxes, realtors fees]), the seller must be close or already in default, the seller must show long-term financial hardship, and the seller must lack substantial assets that could be used to offset shortfalls. However, please note, that even if all those requirements are met, it does not guarantee that a short sale will be approved. The bank will collect all proceeds from the sale which are not used to satisfy closing costs, or other liens. The homeowner will almost always not be permitted to retain any proceeds from the sale.

There are numerous reasons why a short sale may be more beneficial and a better alternative to losing your home in a foreclosure sale. At times, the Lender will agree with a short sale because it is better to recover part of the mortgage loan in liquid funds from a closing, than to take the risk of selling the property at an auction, where the recovery could be much less, and could include multiple additional expenses to the foreclosing bank, including transfer taxes, additional legal fees, paying a broker to list the property for sale if the bank reclaims the property in foreclosure, maintaining the property while it being marketed for sale, and incurring ordinary property expenses like real estate taxes and insurance. It is beneficial for a homeowner in a few ways. First, most lenders will regard a recent foreclosure as equal to a recent bankruptcy, thereby reducing your ability to obtain a mortgage in the future. If you plan on owning another home in the future, you may want to avoid a foreclosure on your credit report. A foreclosure may be quite damaging on your credit report, and may stay on your credit report for up to seven years. Thus, it will be quite difficult and take time to qualify for a new mortgage. While a short sale can also be reported on your credit report, it is more likely to be reported in a less damaging way, which may will help you be a more attractive borrower, though you will still need to wait some time before becoming eligible for a new mortgage.

Another benefit, of a short sale is that creditors typically accept the proceeds of the sale as a settlement, and will give up the right to sue you to recover amounts unpaid after a short sale delivers less than the total outstanding loan, although this is not always the case. Unless the Lender agrees not to pursue legal action, it can file a lawsuit to recover the difference of the unpaid loan balance. If the Lender agrees to a short sale, you must be sure to obtain an agreement from the Lender that it will not pursue legal action to recover the unpaid loan balance after a short sale. This is why is it very important to have appropriate legal representation when involved in a short sale transaction.

In addition, in most cases the Lender will consider any portion of the forgiven debt as regular income to the borrower and will issue a 1099 for that amount to the IRS – meaning that the homeowner will have to pay income taxes on the forgiven amount. This is why it is very important to discuss the tax implications of a short sale with your accountant.

It is very important to get sound legal advice before entering into a short sale transaction, or any other foreclosure alternative. At Menicucci Villa Panzella Calcagno PLLC, we have the experience and legal knowledge to help you find the alternative that’s right for your situation, and to help you achieve your goals.