A short sale, or a pre-foreclosure sale, is a process through which you sell your home for less than you currently owe on the mortgage. In exchange, your lender agrees to accept less than the balance of your loan.
If you are having trouble making payments on your mortgage, you may have heard that a short sale can be the solution to your problems. A short sale is definitely the right choice for some homeowners, but it may not be the best option for you.
Many people will claim that a short sale is better than foreclosure because it will save your credit, but this is only partially true. Your credit will still take a big hit when you complete a short sale for a couple of reasons. Short sales, like foreclosures, will be reported as "not paid as agreed" on your credit file and both are considered the same in determining your FICO score.
Missing payments on your home loan -- even without turning to a short sale or allowing the home to go into foreclosure -- will also harm your credit.
Many sellers are surprised to learn that a short sale does not automatically cancel your obligation to pay the remaining balance on your mortgage. A mortgage has two parts: a promise to repay the lender, and a lien on the property to secure the loan.
When your lender approves the short sale, they are agreeing to, at least, remove the lien on the property. You must find out if your lender is also agreeing to cancel your obligation to repay the loan in full.
Some lenders will ask you to sign a new, unsecured note before approving the short sale. Other lenders, without asking for a promissory note, will reserve their right to collect the remaining balance in the fine print of the short sale documents, which you may not notice until the last minute.
To make sure you won't be left with payments after the short sale, ask your lender and get the answer in writing.
If your lender forgives the deficiency, or the remaining balance, you may owe taxes on this amount, which is considered income by the IRS. The Mortgage Forgiveness Debt Relief Act of 2007 allowed homeowners to exclude all or some of this amount forgiven by meeting certain requirements. This rule expired on December 31, 2013 and, as of February 2014, has not been renewed, although lawmakers are working to have it reinstated.
Despite the drawbacks, there are benefits to doing a short sale on your home. Many sellers enjoy retaining the dignity of selling their home, rather than having it taken by the bank, while avoiding the stigma of foreclosure. Under Fannie Mae rules, you will also be eligible to buy another house in 2 years, rather than 5-7 years with a foreclosure. If your credit does not reflect a 60-day or greater late payment, Fannie Mae guidelines also allow you to buy a new home immediately.