There are some huge misconceptions when it comes to a short sale vs. a foreclosure. I'd like to take the most common myths surrounding both short sales and foreclosures and give a brief explanation., so LET’S BUST SOME MYTHS!!
1.) If you let your home go to foreclosure you are done with the situation and you can walk away with a clean slate. The reality is that this couldn’t be any farther from the truth in most situations. You could end up with an IRS tax liability and still owing the bank money. Let me explain. Please keep in mind that if your property does go into foreclosure you may be liable for the difference of what is owed on the property versus what is sells for at auction, in the form of a deficiency balance! Check your state law as it varies widely from state to state.
Here is an example of how a deficiency balance works:
If you owe $200,000 on the property and it sells at auction for $150,000, you could be liable for the $50,000 difference if your state law allows it.
Not only could you be liable for the difference to the bank, but in some situations you could also be liable to the IRS! Hard to believe? Well, believe it or not, the IRS counts the difference between the sale and the charged off debt as a “gain” on your taxes. That’s right-you lost money and it’s counted as a gain! (I didn’t make that rule, that’s a wonderful brainchild of the IRS).
Guess What? A short sale can alleviate your liability to the bank, in most situations. There are also exceptions to this, but in most cases banks are releasing homeowners from the deficiency balance on a short sale.
2.) There are no options to avoid foreclosure. Now more than ever, there are options to avoid foreclosure. Besides a short sale,loan modifications along with deed in lieu are also examples of the many options. In most cases (but not all) a short sale is the best option. Either way, there are more options today than there have ever been to avoid foreclosure.
3.) Banks do not want to participate in a short sale, or, it is too hard to qualify for a short sale. Banks would rather perform a short sale than a foreclosure any day. A foreclosure takes a long time and creates a huge expense for the banks; a short sale saves both time and money. Qualifying for a short sale is easier than you think, you need to have a true financial hardship, or a change in your finances and your house has to be worth less than what you owe on it.
4.) Short sales are not that common. At this present time, short sales range from 10-50 % of sales in various marketsand it is predicted that in 2012 we will have more short sales than any other year, to date. Due to economic changes in the last few years, this is something that is affecting millions of Americans. Short sales are in every market, and are not just limited to any particular income class. A short sale should be looked at as a helpful tool, not a negative stigma.
5.) The short sale process is too difficult and they often get denied. Though the short sale process is time consuming; it is not as difficult as the media would have you believe. The problem is that most short sales are denied because of a misunderstanding of the process. An experienced agent knows how to avoid this. Short sales require a lot of experience, and a special skill set. If you are looking to go the option of a short sale make sure your agent is skilled and experienced in this area.
6.) Short sales will cost me money out of pocket. A short sale should not cost you any out of pocket money. In fact, you could get between $3000-up to $30,000 to participate in a short sale. In many ways, a short sale may put you in a better financial position than prior to the short sale. As a seller of a property you should never have to pay for any short sale cost upfront to any professional service. Realtors charge a commission that is paid for by the bank. The only potential cost you could incur is if the bank would not release you from a deficiency balance in the short sale, which is happening less and less now.
7.) If I am behind on my payments, I can perform a short sale any time. The farther you get behind on your payments, the harder it is to get a short sale approved. The closer a property gets to a foreclosure the harder it is to convince the bank to perform a short sale. As they get closer to a foreclosure sale more money is spent, thus deterring them from doing a short sale. If you think you need to perform a short sale, time is of the essence; the sooner you start the process, the better.
8.) I have already been sent a foreclosure notice so I can’t perform a short sale. For the most part just because you received a foreclosure notice or notice of default it does not mean that you do not have time to perform a short sale. The timeline and specifics do vary from state to state, I have seen banks postpone a foreclosure to work a short sale option as close as 30 days prior to the scheduled foreclosure auction, but the longer you wait the less chance you have. If you have received a legal foreclosure notice, please reach out to a professional right away. The longer you wait, and the closer you get to foreclosure, the fewer options you have.
9.) I was denied for a loan modification, so I know I will get denied for a short sale. Short sales and loan modifications are handled by two separate departments at the bank. These processes are totally different in approval and denial. If you got denied for a modification you can still apply for a short sale; in some cases you can get a short sale approved faster than a loan modification, as some loan modifications are denied because they cannot reduce the loan low enough based on the consumers income.
10.) If I go through a short sale I cannot buy another house for a long time. The time to buy another house depends on your entire credit picture and can vary from 12-24 months. There are even a few FHA programs that allow for a purchase sooner than that.
These are just a few of the common myths surrounding short sales and foreclosure. With the options available today, no homeowner should ever have to go through foreclosure, and hopefully this information can help a few more homeowners think twice before walking away from their home not realizing the possible long term ramifications a foreclosure can have.
Sean S. Williams
Licensed Broker, Realtor®, ABR®, e-Pro®
1st Time Buyer & Relocation Specialist
of Louisville, Kentucky
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