Home $$s & Sense

Hi Sue,
I had a question I was hoping you may be able to help us with. I have a family member that is losing their home. They are being advised to do a short sale on the property. They have been told that if the house is sold through a short sale they will not be responsible for paying the second attached to that property. So, in essence by doing the short sale, they will be "debt free". They have also been told that it should have minimal impact on their credit and they would be able to purchase another house in six months. That sounds WAY to good to be true!

As you can imagine the Internet is FULL of various information. What the big question at this point seems to be is:
If someone does a "short sale" on their home, are they still responsible for paying the second? And:
Does the short sale have just as much impact to their credit scores as a foreclosure would?

It seems to me that if the short sale affects the credit scores as much as a foreclosure, why wouldn’t you just do the foreclosure?

Hope that makes sense. It's my mom that's losing their house. My husband and I have tried to help out, but as you can imagine, we can only do so much. I just hate to see them getting in to something without enough information.
Please help!

Anxious Anne


Dear Anne,

You are asking very good questions!

It is true that short sales don’t have the same negative impact on one’s credit. In a best case scenario a borrower can purchase a home the day after a short sale. That assumes that all of the borrowers other financial obligations have been paid on time and there is no other negative credit reporting of any kind.

The least desirable scenario is that the borrower must wait a minimum of five years before being able to purchase another home.

In contrast, if a borrower loses a home in foreclosure the waiting period before being able to purchase is typically seven years.

A short sale is when the lender agrees to retire the mortgage debt for less than what is owed. This process literally creates a “debt free” result for the borrower.
Lenders are learning through experience that short sales make more sense than foreclosures. A short sale is easier to manage and less costly than a foreclosure. Sales statistics show that short sales net approximately 20% more than a foreclosure which is also known as an REO or bank owned property.

The second lien holders are generally willing to cooperate in a short sale negotiation because they would get absolutely nothing if the property were to go into foreclosure.

An area of concern when dealing with second lien holders is determining whether or not the loan is recourse or non-recourse. If the loan was a purchase money loan it is generally non-recourse. If it is a re-finance or line of credit loan it is probably a re-course loan. Have a qualified tax professional or real estate attorney make this determination for you.

If the second is a recourse loan, meaning the lender would have the right to recover or go after the borrower for any deficiency because the money wasn’t purchase money, it would be wise to have the negotiator get the lien holder to sign a full release.

The current administration introduced a plan that subsidizes the losses that second lien holders are required to take for loan modifications. The plan has been expanded to cover short sales.

The tax impact from a short sale is also an area of concern. A bill duplicating the Federal Governments stance on taxing debt relief has been introduced. If passed, it would prohibit the State’s from taxing borrowers on debt relief. Always consult your tax professional before entering into a short sale agreement. It’s a matter of good Home $$’s and Sense.

Labels: non-recourse loan, recourse loan, REO, short sale tax debt, Short Sales