As they so often do, an e-mail from a former client reminded me how bad things are in the local housing market. Hi, it began, I think my husband and I need some creative help from you. We refinanced a few times and now owe about $418,000 on our home, and our real estate agent says our best offer may come in at $375,000. Can you help us make this work?
Yes, maybe, I replied, but you won’t like the process or the outcome much. What you’re asking me to do is fashion a short sale for you.
[If you don't know, a short sale is one where a lender agrees to take less than the full amount due under the mortgage, at closing, to facilitate a sale and avoid a foreclosure where the lender would end up with a house to sell.]
I asked my client, have you sat down and examined the pros and cons of a bankruptcy or foreclosure? Do you have enough assets and income to make bankruptcy difficult or impossible, and have a need to buy another house, which will cost a lot more if you allow this house to slip into foreclosure? Because if you have enough income and/or other liquid assets to make bankruptcy impossible, I won’t be able to prove you are so broke that your mortgage lender shouldn’t seek to recover the balance due it after the short sale. And are you sure, client, that when you filled out the application for your latest re-fi, you were brutally honest with your lender, as you’ll be filling another application for the short sale and you don’t want anyone comparing the two and finding there was fraud in the application! I am sure the million dollar fine or decades in jail penalty deterred you from committing mortgage fraud the first time, but I still need to ask…
Also, I asked, is this the only mortgage on the property? A second mortgage lender most likely will not agree to take nothing--and why should it?
So here’s what has to happen, client: we need a contract of sale before we can even negotiate a short-sale. But you can’t sign a contract agreeing to a lower price than your mortgage (unless you are prepared to pay the difference in cash yourself) without an “out” clause to declare the deal null and void if your lender refuses the short sale proposal.
Still with me? If the lender consents to take less than what it is due at closing, either the difference is reported to the IRS as forgiveness of a debt and subject to taxation as income (though you didn’t actually pocket the money) or the lender will demand repayment of the debt over time. And the repayment will be a personal loan, which usually carries higher rates and quicker repayments. So, client, check with your accountant about which option works best for you, if the lender gives us a choice after examining all your assets, income, savings and the like. And make sure your agent tells any potential buyer that we are putting in a clause that allows you to cancel the whole deal at any point up until closing if the lender refuses to allow you to complete the short sale, or proposes terms too onerous for you to repay. With all the other homes for sale in your neighborhood, I’m sure the buyer won’t look elsewhere after hearing that, if your agent is persuasive enough…