Bankruptcy Alternatives: The Short Sale

As my colleague Chip Parker has pointed out, Foreclosure Mediation is taking hold and some banks are actively working to modify mortgage to save homes.  But what if your lender says you don’t qualify for a modification?  Many times, the next best suggestion is to do a “Short Sale“.  In fact, some lenders will require that you at least try for a short sale before they will consider a Deed In Lieu Of Foreclosure.  But that is fodder for another post.

What are the arguments in favor of doing a short sale?

• It’s not a foreclosure.  Many homeowners are caught up in the concept of foreclosure as a sign of failure.  By avoiding the process, you have avoided the label of being “foreclosed”.
• It saves your credit rating.  Since there is no actual foreclosure, many consumers like the idea that it does not show up on your credit report as a foreclosure.
• You don’t owe the bank anything afterwards.  The basic concept of a short sale is that the lender takes the net proceeds of the sale and lets you off the hook for any remaining balance on the mortgage loan.
• There is no visible sign of loss.  Since the bank isn’t actually taking title to your house, there is no adverse record of a foreclosure anywhere.  To the outside world, it simply looks like you sold your house and moved away.  No auction sign, no advertisement, no whispering by the nbeighbors.

To the uneducated, these appear to be huge benefits.  Well, I’m here to burst your bubble and educate you to reality.  While it is true that a short sale is not a foreclosure, here are the realities:

• A short sale hurts your credit nearly as bad as a foreclosure.  FICO, one of the chief companies calculating credit scores revealed that a short sale is considered as bad as a foreclosure in terms of predicting a future credit default.
• It’s not guaranteed that the lender will waive any deficiency.  Although many assume that a short sale resultss in owing nothing more on that mortgage loan, don’t count on it.  The banks will still want to know your financials and will judge whether or not you can afford to pay them more after the house is gone.  Oh, by the way, what about that second mortgage or home equity line of credit?  Don’t forget them.  They’ll want something too.  There may not be enough to go around.
• Everyone knows anyway.  Once you put that For Sale sign in the front yard, the nosy neighbors will want to know what is going on.  After all, new neighbors may affect the neighborhood.  Worse yet, by selling your home for less, that number will reflect poorly on their values as well.  Count on the tongues wagging behind (or in front of) your back.
• You get nothing out of the sale.  Unless your lender allows for some moving expense, you will be faced with all of the costs of relocating – both financially and emotionally.  The only ones who are making any money on this deal are the real estate agents and the lawyers.  (You knew that was coming, didn’t you?)  The agents will get their real estate commissions and the lawyers, well, they always get paid.  Meanwhile, you are out on the street with no money.
• Short sales take a ton of time and are a major hassle.  Just because you have decided to sell your home for less than you owe and the bank has agreed, don’t count on anyone wanting it right now.  Unless that price is bargain-basement, no one will want it in this economy.  Count on the vultures coming in to steal it for even less.
• What about that other debt your owe?  The credit cards, the car loans, the lines of credit; they don’t get that much easier to pay if you don’t have a mortgage payment.  After all, you still need to find a place to live and that costs money.

A short sale may not get you much that a bankruptcy can’t solve.  Heck a Chapter 13 bankruptcy might solve the entire problem by letting you wipe off the second mortgage/line of credit while paying the credit cards nothing and getting caught up on your first mortgage.  That way you get to keep your home and start over.

Failing that, a Chapter 7 bankruptcy will absolve you of liability on the mortgages/line of credit and the credit cards and get you a fresh start.  Just make sure you surrender that real estate properly as part of the process.  And consider this, a bankruptcy may actually help your credit rating a bit; since you can’t file bankruptcy again for a while, your ability to pay is pay in the future is far more important that what happened to you in the recent past.

And as always, contact a qualified bankruptcy lawyer to discuss the specifics of your situation before deciding on any course of action.