Unless you’ve missed every major newscast since 2008, you’ve heard the term “short sale” before and have heard opinions about it – good and bad. If you know much about me, you know I want to share common sense information that will help you, so let’s go through the basics of a short sale.
Let’s begin with a definition of what a short sale is. Wikipedia gives a really good definition: “A short sale is a sale of real estate in which the sale proceeds fall short of the balance owed on the property’s loan. It often occurs when a borrower cannot pay the mortgage loan on their property, but the lender decides that selling the property at a moderate loss is better than pressing the borrower. Both parties consent to the short sale process, because it allows them to avoid foreclosure, which involves hefty fees for the bank and poorer credit report outcomes for the borrowers. This agreement, however, does not necessarily release the borrower from the obligation to pay the remaining balance of the loan, known as the deficiency.”
Notice some key elements from that definition. First, the lender (bank) is agreeing to take less for the property than you owe on it (thus the term “short” sale). Second, it is rare that a bank will agree to a short sale if you are current or only a month or so behind on payments – while I do not recommend going past due; a short sale is not normally an option for someone with a good payment history. Last, you are not automatically released from the losses the bank incurs if they agree to a short sale UNLESS you get them to agree to the short sale WITHOUT RECOURSE. If you are considering a short sale, those two words alone can save you thousands of dollars because that phrase means that the bank will eat the loss and not come after you for it.
Anytime you pay less than you owe on a debt, you should expect something to happen on your credit report and your tax bill. Experts can’t agree and Fair Isaac (the company who developed the FICO Credit Score) won’t tell specifics, but here’s what I’ve seen in my experience. With the short sales I’ve seen credit scores generally fall at least 100 points by doing a standard short sale, which is about the same (a little less) than if you go through foreclosure. If the short sale is WITHOUT RECOURSE (the only way I’d consider it), the credit implications are a little different (not as bad in most cases), but you will usually have to pay taxes on the amount of debt forgiven. The lender will send a 1099 and report it to the IRS. You should also expect a future mortgage lender to ask you questions about it because it will not show up as a standard payoff on your credit report.
Is it Worth It?
I’m a firm believer that you should pay what you owe. Psalm 37:21 says, “The wicked borrow and do not repay, but the righteous give generously” and I’m not sure how that could be interpreted any differently than “pay what you owe.” However, I am a realist who recognizes things aren’t always as simple as we might want them to be. I suspect very few ever sign on the dotted line for a mortgage with the expectation to seek a short sale down the road. That said, it is a hard and emotional decision that isn’t right for every tough situation. Before you decide a short sale is right for you (or bankruptcy or foreclosure for that matter), I would encourage you to get financial coaching.