Short selling homes ranks in the top 10% of the most painful experiences a seller can possibly undergo. Finding the right buyer in today’s challenging market is a hard enough task, but when sellers have to pursue the bank as well, it’s almost impossible. And what do sellers get for their trouble? Bad credit and high tax bill. The dirty secret that banks don’t want borrowers to know: Consumers in the U.S. considering a short sale would be better off simply walking away from their mortgages.
The Short Sell Process
Borrowers living in homes worth less than their mortgage value may need to move for a variety of reasons, but to do so they will have to either make up the difference out of pocket or get the bank's permission to execute a short sale.
If borrowers choose to execute a short sale, they must contact their bank to start the process. First, they must prove to the bank that the home is worth less than the mortgage. Next, they must prove to the bank that they cannot continue to make their monthly payment and they do not have the funds to make up the shortfall on the mortgage. Finally, they must find a buyer willing to wait the 3-6 months it could take to get the approval to execute the transaction.
Borrowers must provide pay stubs, tax returns, bank records, appraisals and other documents to convince the bank that they don’t have the funds and that their home is worth less than the mortgage. If a borrower only proves one of the two, the bank will reject the sale. Additionally, banks delay this process because it forces them to write off the debt immediately. In the case of a foreclosure, they may not write the loan down until they actually take title to the property and sell it. This could be a year or more down the road. Anyone that has been through this process can attest to the fact that banks make it a very unattractive path for borrowers.
Short Sells Result in Bad Credit Scores and High Tax Bills
After all the hard work of making it through the short sale process, borrowers are rewarded with bad credit, a potential tax liability and an IOU. Many borrowers falsely believe that a short sale is an honest way to work with the bank to relieve their mortgage burden without negative consequences to their credit. This is false, plain and simple. While borrowers will not have the negative hit of a foreclosure (-140) on their credit report, they can expect their credit score to decline by at least 100 points.
In addition to the credit score impact, borrowers are also responsible for paying taxes on the portion of debt the bank forgives. This acts as additional income, so it could very well put borrowers in a higher tax bracket. Since none of the forgiveness is taxed at closing, these past homeowners should expect a very large tax bill at the end of the year.
Finally, homeowners should watch out for the claw back provisions in the short sale documentation. Most banks put a clause in stating that they have the right to go after the borrower at a later date to recoup any losses on the mortgage with interest. While this rarely happens, it does happen.
Given the above, short sales seem unwise. Simply walking away from a mortgage is quicker and more cost effective. Banks have made it extremely hard for strapped borrowers to exit the responsible way. Strategically walking away from a loan results in a very similar hit to a credit score, but with much less time, money and energy. Consumers considering short sales should think long and hard about saving the money, a loan modification or simply moving out.
Michael Cook - Michael Cook is currently a Real Estate Investment Banker for Wachovia. He and his partnerstarted their own real estate investment ...
