To Short sale or to Foreclose? I share my experiences

I just got back from my long-awaited California Vacation. 

It was a great to see my relatives, have my kids play with their cousins, eat my most missed fast food JOLLIBEE and to just get away from the normal routine of work-home, work-home.

It has been two years since I last saw my family there.  The last time was when my grandfather died.  It's only four hours away of a drive but for some reason I never felt the need to go because of the problems that I experienced with my failed Real Estate Investments and with the business changing, gas prices sky rocketing-- trips to California was simply forgotten.

The trip, however, was not completely "work-free."

I was successful in spending time with my cousins, aunts and uncles.

What I was not successful in was the fact that I still did some work-Real Estate work (which wasn't all bad).  My auntie's house is next to an Abandoned home which had a foreclosure sale date notice stamped on the front door.

I couldn't help but ask my uncle if he knew if they tried to do a short sale and he said that they tried to but ended the process after the bank rejected the first offer from a buyer--the bank wanted more money.  Nobody made an offer after that, so the neighbors decided to just walk away and foreclose.

I started educating my family about the pros and cons of short sales and foreclosures.  Similar to what I've encountered in the past I had to fight most of their co-workers "expert advice" about the subject.  

My aunt since that time had me talk to three of her closest friends from all over the country.  Places that have been in tough markets where foreclosures and short sales abound:  Arizona, Las Vegas, New York and California.

I wanted to share to you how short sales work and why you should do it: 

Q: What is a short sale?

Answer: A Short Sale occurs when a homeowner owes more on their property than the property is actually worth, but their bank agrees to accept less than what is owed as payment-in-full. In other words, the bank is willing to take a discounted pay-off in order to avoid the foreclosure process.

Q: Why are the banks willing to do a Short Sale?

Answer: Because the alternative is foreclosure, and the foreclosure process is usually more expensive compared to Short Sale.

Q: What are the benefits for the homeowner in a Short Sale?

Answer: The primary benefit to a homeowner who participates in a short sale is avoiding the devastating effects of a foreclosure on their credit. If the loan is VA guaranteed, the successful completion of the Short Sale protects their VA eligibility for future VA mortgage loans.

Q: Can a Short Sale property be a good investment?

Answer: Most of the Short Sale occurs on homes built in the past 3-5 years that were 100% financed.

As many smart investors knows, to make an investment worthwhile, the property must be purchased at no more than 65-70% of it's after-repair-value. Most loans that we have shorted are FHA, which are currently insured at 82% of appraisal which, unless buying to hold long-term, isn't enough equity for an investor.

What you will find in working Short Sales is that unless a property is in horrific condition, banks will rarely discount the loan below 75-85% of it's appraised value. Since 95% of our leads are first-time homebuyers who have over-extended themselves in buying a brand new home, the banks simply cannot discount the property enough for it to qualify as an investment opportunity.

Q: What is a Deficiency Judgment?

Answer: A deficiency judgment is simply the difference between the mortgage balance and the discounted amount accepted by the bank as a result of the Short Sale.

Technically, the bank can pursue a deficiency judgment for the amount that they discounted the loan. When negotiating with a Short Sale, the ultimate goal is to get the bank to accept the Short Sale amount as payment-in-full.

Sometimes, the bank will pursue a deficiency judgment against the homeowner. As part of your negotiations, you should require that the bank waive their right to any future deficiency judgment against the homeowner.

For FHA and VA loans, the banks are required to waive the deficiency. For Conventional Short Sales, sometimes the bank will either attempt to pursue a deficiency judgment or require the homeowner to carry back a separate interest-free note payable in the amount of the deficiency. If the bank do pursue, this amount can almost always be negotiated, and should be. 

Note: please check the DEBT RELIEF ACT of 2007, which was enacted in December.

Q: Are there potential tax ramifications to the homeowner for doing a Short Sale?

Answer: When a bank accepts a Short Sale, the IRS considers the shortage on the net amount received verses the principle amount that was due to be "forgiveness of debt".

Furthermore, the IRS deems this "forgiveness of debt" to be taxable income. In order to be in compliance with the IRS rules, banks are required to issue a Form 1099 for the amount of the debt forgiven (please check Debt Relief act of 2007, link above.)

Q: What is the impact on the homeowner's credit for doing a Short Sale?

Answer: A Short Sale is reflected on the homeowner's credit report as something to the effect of, "Discounted Payoff, Paid-in-full". A Short Sale is far less damaging to the homeowner's credit than a foreclosure or a deed-in-lieu of foreclosure.

These are just some of the Frequently Asked Questions about this topic. If you have any other questions, you can talk to me directly:

Joe Salcedo

Cell: 775-338-7653

Email: jsalcedo@chaseinternational.com