In the previous articles we introduced this ‘Now What Do I Do?’ series, and discussed Option 1 – Sit Tight and Option 2 – Loan Modification.
Now what if you really can’t make your mortgage payment? Not even reduced ones. Lost your job or got injured…. Savings running out…. This is tough stuff. But a lot of people are going through it. Now maybe it’s time to consider Option 3 – doing a Short Sale. Selling your house for less than you owe, and getting the bank to take the deal, even-up, so you can walk away free and clear.
The advantage to you in doing a short sale is that a successful short sale should be less damaging to your credit than a foreclosure, and allow you to financially recover more quickly. You won’t get any money out of the deal, except maybe some moving costs, but you’ll be out from under that mortgage and free to get on with your life.
A ‘short sale’ means to sell the house for less than you owe on it, and get the lender to accept that lesser amount as payment-in-full, i.e. a short-payoff. You can see why the banks and lenders aren’t too fond of the notion. But if the alternative is for the house to sit empty for 6 months or more, while no payments are being collected, and then for the bank to have to take it back at a foreclosure sale and try to sell it themselves, maybe it starts to look like a reasonable alternative to them.
But you’d never know it by the ways the banks have been behaving – very difficult to get in contact with, endless delays on getting an answer on an offer to buy, etc. This situation left you hanging as the seller, not knowing if you were actually going to be forclosed, and left the buyer hanging, not knowing if they had a deal. The result was that many deals were hanging in limbo, many potential buyers were walking away, or staying away, from short sales, and agents were having to push offering prices ever further downward to try to get someone to make an offer. That hurts market and neighborhood prices even more. Not good for anyone.
But finally the banks and lenders are coming around. Once again pushed hard by the government. A new set of regulations went into effect April 5th. These regulations, called HAFA, are another part of the federal Making Home Affordable program. Whatever you think of how we got into these problems, and whatever you think of the current administration in Washington D.C., these programs are helping get things sorted out, and they may be able to help you in your situation.
HAFA stands for Home Affordable Foreclosure Alternatives, and it applies to your primary residence only. It is 43 pages of regulations and directives that are enough to make your head ache trying to read them. The link above is the best shorter summary I have been able to find, produced by the National Association of Realtors.
The HAFA program should make it easier to short-sale your house and get out from under your mortgage. Many of the biggest banks and lenders in the country have signed up for it. It also provides some direct help for you – up to $3,000 cash at closing for moving assistance. And a successful short sale should be less damaging to your credit than a foreclosure, and allow you to recover more quickly.
However, not all lenders are participating in HAFA, and if they are not, there are some other risks in trying to do a short sale. In particular, they might try to get a Deficiency Judgment against you for the difference between the value of the property and what you owed them at the time of foreclosure.
Bear with me on a bit of legalese here, and recall that I am not an attorney. Washington state has provision for two kinds of foreclosure, called Judicial Foreclosure and Non-Judicial Foreclosure. Almost all residential ‘mortgages’ written in Washington are actually ‘deeds of trust’. The deed of trust has a third party ‘trustee’ who actually holds the deed to your house, and includes an ‘acceleration clause’ which allows the lender to demand payment in full ‘immediately’ if the borrower defaults on the payments, and a ‘power of sale clause’ which says that if the borrower has defaulted, and cannot pay, then the lender can initiate Non-Judicial Foreclosure. A Non-Judicial foreclosure is executed by the ‘trustee’, meaning it doesn’t have to go through the courts; the trustee can simply follow the notification procedures and minimum timelines defined by state law, and proceed to sell the property at a public foreclosure auction held at a county courthouse. In Washington state law, when a home is sold at a non-judicial foreclosure sale, the lender cannot later pursue you, the borrower, for a deficiency judgment for the difference between the value of the property and what you owed them at the time of foreclosure. Your debt on the original ‘mortgage’ is simply wiped out, along with most liens on the property, and you no longer have any rights or obligations to the property.
The kicker in all this is that the lender also has the right to instead choose to pursue a Judicial foreclosure, through the courts, and in that case they can also pursue a deficiency judgement. The main reason lenders don’t do this is that in a judicial foreclosure, you retain the right to redeem the property for a period of one year. While it is pretty unlikely that you would do that, the possibility of redemption claim would certainly create a big problem in the mind of a potential buyer when the lender tried to re-sell the property, so generally lenders don’t try to go the Judicial Foreclosure route.
So what’s the point of all the legalese? Simply that if your lender will not give up the right to a deficiency judgment, and that would be a significant overhanging debt for you, maybe you are better off just letting the property go into foreclosure and wipe the slate clean that way. Once again, if you are in this kind of situation, talk with an attorney, and maybe your accountant and financial planner. In the past, the IRS has said that you have to count forgiven debt as taxable ‘income’; the Mortgage Forgiveness Debt Relief Act of 2007 changed that so at least for now, and through 2012, you can generally exclude that debt-forgiveness ’income’ from the discharge of debt on your principal residence through mortgage restructuring or foreclosure.
One more caveat on these options is that your loan may not even be held by a lender who can make a decision. It may have been ‘securitized’ and packaged into a bundle of some kind that could have been sold to an investor almost anywhere in the world. It will take quite a bit of time to untangle the more complicated pieces of this mess.