There’s a lot of information out there about preparing for a short sale: how to decide whether a short sale is right for you, how to qualify for a short sale, and how to choose a team of industry professionals who will help you along and advocate for you.
But what about after the short sale? A short sale is a strategy for homeowners who are saddled with underwater homes, or mortgages that they cannot afford, to get financially back on track. But the short sale itself is not the end of the road. You may still have a deficiency balance or an unsecured promissory note to settle with your lender, you may be worried about your credit score and your ability to qualify for a new mortgage, and you may have income tax obligations following your short sale.
This post answers those questions: What happens after the short sale?
Dealing with the Deficiency
In most of the cases that we process these days, when a short sale is approved the lender also agrees to forgive any deficiency balance. This means that, if the net proceeds from your short sale are less than what you owed on your mortgage, in most cases your lender will not require you to repay the difference (the deficiency balance).
However, in a minority of cases - usually when we are dealing with very small lenders such as credit unions - the lender does not forgive the deficiency. Their approval of the short sale is contingent upon the homeowner agreeing to repay any shortfall still owing after the sale of the home.
The difference between this type of debt and the original mortgage is that this debt, after the sale of the home, is not secured. There is no home, or other property, put up as collateral in the case of non-payment of the debt.
One way of shedding unsecured debts is by filing for bankruptcy. Bankruptcy is not the best choice for everyone, but for a former homeowner who is now saddled with a deficiency balance, and who has other unsecured debts (such as credit card balances, unpaid medical bills, etc.), bankruptcy may be a good option.
However, another strategy that works well is called “debt settlement.” Debt settlement involves negotiating with your lender.
For example, let’s say you still owe your lender $50,000 after the short sale of your home. Your lender knows that they may or may not ever see this money. You may not even have the means to pay it anyway - and, as an unsecured loan, they don’t have many options on how to pursue you for it. They also know that, if they do pursue you, you may just turn around and declare bankruptcy, and then they will never receive anything.
This means that your lender is open to negotiating. Just because you owe $50,000 on paper, doesn’t mean that they necessarily expect to ever see that $50,000. Our debt settlement specialists are often able to get lenders to agree to accept 10 or 20% of the debt owing, in exchange for writing off the remaining balance. Many lenders would prefer to receive $5,000 right now, than hold out for $50,000 that they may never see.
Dealing with Unsecured Promissory Notes
In some cases, as a condition for approving a short sale, a lender may require the seller to pay a cash contribution, or to sign a promissory note - where the seller agrees to pay the lender a specific amount over a set period of time. The idea behind cash contributions and promissory notes is that, since the lender is taking a loss on the short sale, the seller should also contribute something towards mitigating that loss.
If you have signed a promissory note because your lender made that a condition for your short sale approval, the process after the short sale works just the same as that for a deficiency balance, as explained above. The promissory note is an unsecured note. It can be removed through bankruptcy, and it can be open to negotiation.
If you owe an unsecured balance to your lender, whether as a deficiency balance or through a promissory note, your best bet is to get a negotiating team that is experienced in debt settlement working for you. Your team should explain to you exactly what your options are, and then get to work, negotiating with your lender with the aim of settling your unsecured debt permanently - often for just pennies on the dollar.
(Doing your own short sale? Make sure you don’t get stuck with the bill! Use this guide to decipher the language your lienholder used in the deficiency waiver, and find out if you owe any money or not.)
You can expect your credit score to drop temporarily following a short sale. The “hit” is usually quite small, relative to the hit from a foreclosure. We are hearing reports of drops of 60 points or even less, or perhaps closer to 100 points if you were delinquent on several of your mortgage payments.
The good news is that your credit score rebounds more quickly after a short sale than after foreclosure. That’s because a short sale is recorded as a settled debt. In general, you will see your credit score starting to recover in as little as six months after your short sale. You can work to actively rebuild your credit score, too, by using credit cards and paying them on the due dates, demonstrating that you are a responsible borrower.
Even though you don’t receive any money from the sales proceeds of a short sale, if your lender forgives some of your mortgage debt, the IRS may treat that forgiven debt as “income.” This means that you could be liable to pay income tax - on money that you never actually received! In addition, if you received any cash incentive payments - for example directly from your lender or through a government program such as HAFA - these payments may also be treated by the IRS as income.
The Mortgage Forgiveness Debt Relief Act of 2007 was originally implemented to relieve homeowners of having to pay income tax on forgiven mortgage debt related to their primary residence. Unfortunately, that act expired at the end of last year and, at the moment, there is no word on it being revived.
However, there is still hope for homeowners who have had mortgage debt forgiven through a short sale. There is a specific IRS clause called the Insolvency Clause. Consumers who have had debt forgiven (and this applies to any debt, not just mortgage debt) may legally avoid paying income tax on their forgiven debt if they can demonstrate that they were insolvent on the day that their debt was forgiven. Most homeowners who have lost their home through a short sale will be able to qualify for the IRS Insolvency Clause, which we wrote about in detail earlier this month.
Having a foreclosure on your record can make it tough or impossible to qualify for a new mortgage for five to seven years. In contrast, following a short sale, you can qualify for a new mortgage in as little as two years.
The key to qualifying for a new mortgage is to rebuild your credit history and credit rating, so you can present yourself to a new lender as a responsible borrower. If there were specific hardships that led up to your short sale, keep a record of them so you can show them to a new lender. Spend responsibly, minimize or pay off your other debts, and save for a down payment. Take a look at more specific guidelines in our December post on how to qualify for a new mortgage after a short sale.
At Ark Law Group, we know that being in debt is about so much more than just numbers. We understand the pain that debt causes, and the personal toll it takes on families and on relationships. We are here first to listen - because we know that everyone's situation is different. Once we understand your unique circumstances and your individual needs, our team of attorneys and financial professionals will help you find the best and quickest solution to your personal debt problems. For a free, no-obligation consultation, tell us about your situation or call us directly at 1-800-603-3525. Lambros Politis can also be found on Google +.