Here it is. Our final installment. This is one of the most important parts: How Will A Short Sale Affect You. If you missed any of the preceding parts, you can find them here:
This part is most critical, and is the subject of great speculation and debate, and is surrounded with misunderstanding. I strongly advise you to seek appropriate legal counsel regarding your specific circumstances and any legal, tax, or personal credit consequences for your unique situation. State law varies on these issues, and many issues are still being worked out and examined by CPAs, attorneys, and state legislatures.
Three Key Issues
The three most important considerations for anyone looking to do a short sale are, lender’s recourse, taxes, and credit. It all boils down to: how is this going to affect me? Why would I do a short sale, as opposed to just letting the bank foreclose on the home and take it away from me? These are the issues we’ll tackle today, and I’m fairly certain that there will still be plenty of questions in your mind. This is a complex beast, and we’ll take the issues in stride. One of the key considerations, and an issue that changes things dramatically, is: What is the nature of ownership?
Do You Actually Live There?
There are many “protections” in place for people who are down and out and facing foreclosure. Many of these protections are for people who are facing the loss of their home. People (and the law-makers that derive form them) have a broken heart for those who are hurting and need help. The heart-strings of the masses do not however, play a sad dirge for “speculators”. Let’s make a distinction here. You either bought a home to live in it, or you didn’t. This does not apply to those of you who purchased a home and lied on the application in order to get a primary occupancy rate on your mortgage. Many of the legal protections in place do not apply to investors or short-term “property flippers” who simply got stomped in a series of poorly timed events. So, what are the protections for the standard homeowner?
The Mortgage Forgiveness Debt Relief Act of 2007
In late 2007, the U.S. Congress passed, and President Bush signed, The Mortgage Foregiveness Debt Relief Act of 2007. Go check it out. I’ll paraphrase it here, for those of you who aren’t versed in political speak: If the bank agrees to take less that you owe them on the sale of your primary residence, you will not have to pay taxes on the forgiven amount. Before the passage of this legislation, for example, if the amount “forgiven” is $50,000, the person being forgiven the debt would receive an IRS Form 1099 for that amount. This means that, for tax purposes, and in the year in which the debt was forgiven, you just made an addition $50,000 of income. And the government wants its cut. Now, with the passage of the bill, you are forgiven the tax debt also. Very nice.
Recourse vs. Non-Recourse
Here is the pertinent Arizona Revised Statute in regards to Recourse on Loans for Real Property. This statute is a little verbose, and in order to clarify as best I may, let me offer this by way of explanation. If an individual buys “. . .a parcel of real property of two and one-half acres or less which is limited to and utilized for either a single one-family or single two-family dwelling,” and if the property’s value has not decreased “. . .because of voluntary waste committed or permitted by the. . .” homeowner, then the bank does not have recourse (the right) to make you pay the difference if the short-sale is less than the amount owed. This also applies to the circumstance wherein the home is foreclosed upon. In other words, you cannot be made to pay a deficiency on the loan, unless it can be proved that the property is worth less than you paid for it because you decreased its value by intentional neglect or wanton destruction. So, if you are being foreclosed upon, and you are angry, and a generally hostile personality, you may tear the house apart in your wrath. You will however, have to pay for the damages you cause. Don’t do it. As a side-note, mortgage notes have clauses in them that deal with whether or not they are recourse vs. non-recourse in nature. If you have a loan in Arizona, and the loan documents state that it is a “recourse loan,” if you otherwise qualify under the above circumstances, there is no recourse for the lender. Regardless of what the loan documents say. So, does this Arizona Statute on recourse apply to investors, or people who buy the home for something other than living there? On the surface, it appears that it does. I cannot however, make this assertion definitively. It would require a legal mind and case law greater than mine to answer this question.
The Case Against Your Credit Rating
If you are involved in a foreclosure or a short sale, will your credit score suffer? Absolutely. There is only one case that I know of where the borrower’s credit score was not directly damaged, and I detailed that case in Part I of this series. Now on to the larger question. Where and how does the damage occur? Consider this. The real damage occurs because, if you are having a hardship, and you are not paying your mortgage, every time you miss a payment, it counts against you. For example, if you have determined that you are going to let the property go into foreclosure, and you are not going to pay your mortgage any more, each payment you miss counts against you. How many are you going to miss? Plenty. It will take, on average, 6 -9 months for the foreclosure process to be complete. Every one of those months of missed payments counts against you. On top of that, when the property is foreclosed upon, the fact that a foreclosure took place will also be noted on your credit report. A double whammy.
The Case For The Short-Sale
So, if you’re going to have credit damage either way, why do a short sale? Well, it’s a matter of degrees of damage. Usually, a short sale will take 2 – 4 months to completely process. Therefore, the damage is limited to the amount of months of missed payments. If the homeowner has determined that they are having a hardship, it pays to look at all options to resolve the conflict sooner, rather than later. It you are already behind on payments, it pays to get the short sale started ASAP. This alone will mitigate the damage to your credit score. The longer you hold on, or do nothing, the greater the damage.
What Does The Future Hold
How long is the damage going to last? Depends on the degree of initial damage. It has been guestimated (too early to tell, really) that a person who undergoes a short sale will probably not be able to get a new loan for another home for a minimum of 2-3 years. If, on the other hand, you undergo a complete foreclosure, you can expect to not be abe to get sufficent recovery so as to purchase a new home for 5-7 years.
So, I have presented as much information as I have, and I hope it has been helpful and informative for you. Thanks for waiting patiently for this final installment, which I’m fairly certain was of primary interest to you who are considering a short sale. As always,
I am NOT an attorney, a CPA, nor anything else important-sounding, and I don’t even play one on TV. If you need help with your specific case, you are encouraged to seek the advice of competent legal counsel. If you have a need for help in any specific area, you are welcome to contact me for a referral to a qualified professional in your area. Thanks for joining us.