Liberty Financial

1. What is a shortsale?

When you owe more on your home than it is worth, what do you do? One option is to ask the lender to reduce the amount that you owe on your loan so that you can sell the property. If the lender agrees to forgive some of your mortgage debt to enable you to sell your property, this transaction would be considered a "shortsale".

2. What are the pitfalls in doing a shortsale?

Many articles have claimed that cooperating with the lender instead of throwing the keys in the mailbox and walking away from the property will preserve your credit rating. This is misleading. If the lender takes a loss on a mortgage, that information will be reported to the credit bureaus. Whether the report states "settled for less than amount owed" or "foreclosure", your credit is marred and that blemish will remain on your credit report for 7 years. In the past, lenders would forgive the blemish and grant you a new mortgage after the foreclosure/shortsale after four years, if the credit subsequent to the mortgage problem is perfect. So don't despair.

Another very unpleasant surprise for many sellers who cooperate in a shortsale is that the lender will send the seller a 1099 for the amount of mortgage debt that was forgiven. Although you have lost your home and blemished your credit, the punishment is not quite over with because the IRS now wants to inflict a little more misery on you. The 1099 you receive from the lender for debt forgiveness will be taxed as ordinary income…just as though you received a big W-2 without any taxes being withheld. This comes as quite an unpleasant shock to most sellers in this dire situation. Frequently, neither the realtor nor the lender informs the sellers that their financial problems will not be over when the home closes escrow. There are some circumstances where debt forgiveness will not be taxable. Consult your CPA before making any financial decisions.

Perhaps the biggest benefit to cooperating in a shortsale is that you can control the amount of the loss on the property and limit the amount of the 1099. If you walk away from a property, the lender may take 6 to 12 months to get the property resold. In a declining market, this could mean a much larger loss on the property. A shortsale helps both the lender and the seller "stop the bleeding."

Keep in mind, there are no winners in this predicament. Contrary to what many people believe, lenders do not want to be in the real estate business. Owning and managing real estate that will later be sold at a loss is not a lender's idea of a good time. Lenders are in the business of collecting interest on loans in good standing. Handling foreclosures and loss mitigation is not something they are set up to do in loan servicing. Lenders have to set up a new department or outsource foreclosures when they become frequent problems.

A foreclosure is the legal process in which the lender takes back property that was pledged as collateral for a loan that is in default. The foreclosure process begins when a lender files a Notice of Default with the county recorder's office telling the amount that is in default and the deadline the borrower has to cure this debt. The notice is also mailed to the borrower.

If the debt is not cured by the date given on the Notice of Default, the lender will then post a Notice of Sale, which must be posted at least 20 days before the sale is to take place. The Notice of Sale must be posted on the property itself and also in a public area. The Notice of Sale is also published once a week for three weeks in a local newspaper or publication. This notice is also mailed to the borrower and must be sent to anyone who requests a copy. The Notice of Sale must state the exact date, time and place the sale will take place, and also must contain the lender's contact information. The Notice of Sale must also be recorded with the county recorder's office 14 days prior to the sale.

The sale is a public auction and the property goes to the highest bidder. The lender can require that the bidder/buyer pay with cash or a cashier's check, but not all do so. Anyone can bid at the sale, including anyone else who may hold a lien against the property. After the sale, the lender transfers ownership to the winning bidder and the previous borrower no longer has any rights to the property.

If you are behind in your payments, call your lender immediately! They may have other alternatives to foreclosure that can help you keep your home.

Family Intervention - In some cases a family member will be willing to buy the property from you and obtain financing that is low enough to enable you to keep the property. This is seen oftentimes between parents and children. If you have a family member that is willing you help you out, whether it be buying the house from you and continuing to let you live there and make payments, or lending money to bring your payments current or pay off the loan, this would be the first place to start.

Personal loan from the lender - One way to avoid having your credit blemished when you owe more than the property is worth and must sell is to be proactive and talk to the lender about your situation. If you speak with the right person, lenders have actually given creditworthy borrowers a personal loan for the difference between what you owe and what you can sell the property for. It is actually in the lender's best interest to do this, as they would still be collecting interest on some money and would not suffer a loss on the mortgage debt. It would be a good thing for the borrower as well because his credit would remain clean. There are solutions that allow everyone to win.

Forebearance - Your lender may grant a special forbearance which could include a reduction of your payment, or even a temporary suspension of your payment. This can give you up to a couple months to get back on your feet and come up with the amount that is delinquent. You may qualify for this if your income has recently decreased dramatically, or if you have experienced a significant increase in your monthly expenses. You will be required to provide income and expense information to the lender to ensure you meet their requirements for forbearance.

Loan Modification/Renegotiation - This is often referred to as "loss mitigation". Your lender may be willing to work with you on a loan modification/renegotiation or even a refinance. A loan modification would be where the lender modifies the current terms of your loan to help you keep your loan at a payment you can afford. This may include lowering the interest rate or extending the term of your loan. A renegotiation would be like a refinance, where the lender would write a new loan for you with terms that will enable you to afford your property. Knowing these options may help if you have recently experienced a sharp increase in payment due to your loan rate adjusting upwards or a circumstance in your life has made your home unaffordable. You can easily avoid huge payment increases by understanding the terms of your loan and refinancing before the loan begins to adjust.

Partial Claim - (Credit to www.hud.gov web site) Depending on the kind of mortgage you have, your lender may be able to work with you to obtain a one-time payment from the FHA-Insurance fund to bring your mortgage current. You must be at least 4 months behind in payments, but no more than 12 months and you must be able to prove that you can begin to make full mortgage payments once everything is paid current. When your lender files a Partial Claim, the U.S. Department of Housing and Urban Development will pay your lender the amount necessary to bring your mortgage current. You must execute a Promissory Note and a lien will be placed on your property until the amount is paid in full. The Note is interest free and is due when you sell or refinance the loan.

The first thing to do is contact your lender and find out if you are eligible for any of these options. Remember that all is not lost. There are things to be aware of though, as there are predators out there that will prey on those in financial trouble. One example is:

Equity skimming - In this type of scam, a "buyer" approaches you, offering to get you out of financial trouble by promising to pay off your mortgage or give you a sum of money when the property is sold. The "buyer" suggests you move out quickly and deed the property over to them. They then collect rent for awhile, don't make any mortgage payments and allow the lender to foreclose. Remember, signing over your deed to someone else does not relieve you of your obligation to pay the loan.

Remember…never sign anything that you don't completely understand. Don't sign anything relinquishing your right to the property unless you are formally released by the lender from your obligation to repay the mortgage. Check with a lawyer or your mortgage company before entering into any deal involving your home. If you are selling the house to avoid foreclosure you can check to see if there are any complaints against the prospective buyer. Contact your state's Attorney General, the State Real Estate Commission or the local District Attorney's Consumer Fraud Unit for this information.