As I’m not a homeowner I don’t really pay attention to articles about foreclosures, or specifics about real estate. But a recent change in my life means I may be in the market in the near future. So the headlines have started to grab my attention. The Washington Post recently ran an article about short sales. I knew in theory how a short sale worked in real estate but not really in practice. But since Freddie Mac approved 22,000 short sales in the first half of 2010 vs less than 100 in the first half of 2007, I thought it was time to get educated.
A short sale in real estate is very different from a short sale in stocks. So step one is not to confuse the two. Let’s say you took on a mortgage of $400,000 on a house that a few years later is only worth $300,000. This is commonly referred to as an underwater house. You’d have to get wet to get out of the house, something people like to call “taking a bath”. If you sold the house you’d have to give the bank another $100,000 to close out the mortgage. If you don’t have that kind of money then you can’t sell the house. But if you can’t afford the payments then you may have to walk away. This is when the bank would take over and foreclose on your home. Next to bankruptcy, there aren’t many other things that can damage your credit as much.
But there’s another way! A short sale. A short sale allows you to sell the house at a loss without bringing the extra $100,000 to the table. The hit to your credit doesn’t exist or is less painful than a foreclosure. So why doesn’t everyone do a short sale instead of a foreclosure? A short sale requires the OK from a lot of parties. Any other loans you have against the house have to okay it, homeowner’s associations get to weight in sometimes, and of course you have to convince your bank.
Convincing your bank may not be that hard. In a foreclosure they still have to take a loss on the house because they’ll have to sell it themselves. This process is much faster and they can get your loan off their books much faster. But there is a catch. You may still owe that $100,000. The bank calls this a deficiency and if your short sale contract doesn’t indicate that the sale price is considered payment in full and the loan closed the bank may come back and ask for that money. I’m not in the business so I don’t know how common this is, but from what I understand they only pursue people who they think they could really collect on. If you’re negotiating a short sale, be sure to read more than this simple post but also be sure to ask for no deficiency.
There other other concerns. Depending on the nature of the short sale and how you bought they house, you may have some taxes to pay. Consult your accountant of course.
But perhaps the biggest problem comes back to the bank. They’ve ramped up their foreclosure departments to handle all the people that simply walk away from homes, but the short sale departments are… short staffed. They also use predetermined criteria for approving a short sale so if you don’t fit in their checklist you’re going to have to do some sweet-talking. As a result foreclosures remain much easier. But I think many would be fools not to try a short-sale first.
Photo: aechempati
 By The Weakonomist |
The Weakonomist is the founder of Weakonomics. Clicking the picture of the puppy will tell you more about him. If you like what you're reading consider subscribing to the blog, following him on Twitter, and checking out the related posts below. Please consider a donation if you really enjoy Weakonomics. Also keep in mind that nothing I say can be construed as financial advice. |
