Recently on our bankruptcy forum a user asked, “My husband and I have both been out of work for six months. We were trying to avoid foreclosure and thought maybe we could negotiate a short sale of our home. Can you tell me whether this is a good idea? What are the risks of a short sale?”
What is a short sale?
A short sale will allow you to negotiate a sale of your home to a homebuyer for less than the remaining balance on your mortgage. The upside for you is that the lender agrees to accept the sale price and to release the lien on the property. It also allows you avoid foreclosure.
Unfortunately, there are some risks with a short sale. Let’s discuss the top risks below.
Top risks of a short sale
- Seller may be liable for deficiency after a short sale.
One of the biggest risks following a short sale is that you may still be liable for the deficiency after the sale. For example, if you owe $150,000 for your mortgage but you sell the house for $100,000, there is a difference in the mortgage owed and the sale price of $50,000- referred to as the deficiency.
Although some states have barred lenders for suing for repayment of the deficiency following the short sale, other states have not. If your state allows for the lender to sue for the deficiency the lender may seek a personal judgment. If they win, they may be allowed to garnish your wages or levy your bank account for repayment.
To avoid this issue, you will need to ask the lender to waive their right to seek a deficiency judgment, try to get them to accept a settlement, or you can file bankruptcy following the short sale and potentially discharge the deficiency, which is now considered unsecured debt.
- The process is painstakingly long and complicated.
Whether it’s the inefficiency of the short sale approval process, the increased risk that the lender will reject multiple offers, or the fact that multiple departments within the lender’s business must be involved, short sales are notoriously difficult to complete. With this mind, even if you have several interested buyers, it’s not unusual for them to get frustrated and walk away from the sale.
- All second mortgage holders must approve the sale.
Another risk if you have multiple mortgage holders, is that they all must agree to the sale. This might not seem too complicated, but it’s not unusual for a seller to get excited and think the sale is a sure thing only to have the second mortgage holder kill the deal.
- Consider the tax implications.
Finally, it’s important to remember that if you do successfully complete the short sale and the lender decides to forgive the deficiency amount, there is a chance that the forgiven debt may be considered taxable income and may need to be reported to the IRS.
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