February 23rd, 2011

The Pros and Cons of Short Sales

What is a Short Sale?

Before you decide to do a short sale, make sure to consult with an Arizona real estate lawyer, an Arizona foreclosure lawyer or an Arizona bankruptcy lawyer to determine what liability you may face.  A short sale is nothing more than obtaining the lender’s consent to sell your house for less than what you owe.  For example, if you have a $200,000 first mortgage and a $50,000 second mortgage and can sell your house for only $140,000, you have to get permission from both lenders before proceeding with the sale.  Why?  Because no buyer will purchase a house without the seller’s lenders releasing all mortgages from the property at the closing (which is also necessary for the buyer’s lender to record its own first position mortgage against the property).  Before this current real estate crisis, there was usually enough money from the sale proceeds to pay off all existing loans and allow the owner to transfer title free and clear to the new buyer.  That is no longer the case for most people, and the only way to transfer title for many properties is to do a short sale or let the property go into foreclosure.

Can the lender still sue for the deficiency amount after the short sale?

A common question is whether a lender can sue for any deficiency amount, even if the lender has consented to the short sale.  If the lender agrees in writing not to sue you for the deficiency amount after the short sale, then you will generally be protected against such lawsuits.  But this is frequently a difficult promise to get in writing, particularly from a second lender who gains nothing from the short sale (if you pay the second lender a little money at the closing, the lender may have an incentive to waive the deficiency in writing, but most people do not have money to pay).  Without this written promise, the lender may be able to sue you for any deficiency amount.  This is sneaky because the lender will not necessarily disclose this unfortunate consequence when you are negotiating the short sale.  The end result is that the owner wastes a bunch of time and money and jumps through a bunch of hoops, only to be sued a few weeks after closing escrow.

Arizona Anti-Deficiency Statute

Under Arizona law, if a person has a mortgage for property utilized as a residence located on two and one-half acres or less and a trustee sale occurs (a trustee sale is the equivalent of a foreclosure here in Arizona), the lender generally cannot sue you for any deficiency amount.  For example, if you took out a $350,000 mortgage and the house is only worth $250,000 at the time of foreclosure, the lender cannot sue you for the $100,000 deficiency amount.  The anti-deficiency statute only applies to residential mortgages, not commercial mortgages.  Furthermore, the anti-deficiency statute usually does not apply to second or third mortgages that were not originally taken out to purchase the house (i.e., HELOCs).  For more information on the Arizona anti-deficiency statute, click here.

Can the lender that consented to the short sale sue you for the $100,00 difference if the anti-deficiency statute would apply in a foreclosure?  Remember that the anti-deficiency statute only kicks in when a foreclosure takes place.  A short sale is not a foreclosure. If you don’t get the lender to promise in writing not to pursue the deficiency amount, you may still be sued after the short sale has been completed.  And once you are sued, you may have to file a Chapter 7 bankruptcy  or a Chapter 13 bankruptcy to avoid paying a very hefty judgment.

Tax Consequences

A lender that has consented to a short sale will frequently issue a 1099 for “debt forgiveness”.  In a nutshell, this 1099 may require the seller to pay income taxes on the amount of debt that was “written off” via the short sale.  That being said, you may not have to pay such taxes depending on your financial situation at the time of the short sale and if your mortgage debt was more than what you paid for the property.  The Mortgage Forgiveness Debt Relief Act will most likely help you avoid tax consequences for a short sale of your primary residence, but that law is set to expire at the end of 2012.  Consult a qualified CPA and an experienced Arizona real estate lawyer to assess your situation.  This topic will be discussed further in a separate article.

So why even do a short sale?  I wonder that myself!

The main reason why a seller wants to proceed with a short sale in lieu of a foreclosure is because the seller believes a short sale will minimize damage to the seller’s credit report.  This is not necessarily true.  Both a short sale and a foreclosure will adversely impact a person’s credit.  Exactly how remains a mystery.  Let’s face it:  Even the CIA can’t crack the “scientific algorithm” the credit bureaus use to compute a person’s credit report (for all we know, the score changes day to day based on the alignment of the stars and the moon).  Also, you need to determine what your credit report looks like now.   If it is already damaged because you are behind in mortgage or credit card payments, then the harm has already occurred!  For more information on credit scores, go to www.myfico.com

Some claim that a person may be able to qualify for a future home loan sooner if a short sale is utilized in lieu of a foreclosure.   That does not mean you will qualify for the future mortgage.  It just means that you may not be “automatically disqualified”.  It also assumes that lending standards will be the same in the future as they are now (and they have been changing almost every day since this “great recession” started back in 2008).

The moral of the story is to use an experienced Arizona real estate lawyer or an Arizona bankruptcy lawyer to make sure your proposed short sale will not create more problems than perceived benefits.  Proceed with caution.

Click here to read important information from the Arizona Department of Real Estate about short sales.

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6 Responses to “The Pros and Cons of Short Sales”

  1. Madge says:

    So what would the point be of doing a short sale if the lender specifically states in the LOA they retain the right to pursue the deficiency on the first mortgage?

  2. Julie says:

    So from the above information, living in AZ and as AZ is a non recourse state, non recourse applies to foreclosure not short sales? Also, if you do opt to short sale, you have given the lender all your current information, you may prove that you actually can pay off the deficient amount, would they more likely lean toward suing for the deficient amount? Going into the process of short sale, does one have any assurance that the lender will provide written assurances that they will not come after the deficient amount? Thank you for your time!

    • Scott Hyder shyder says:

      AZ is not necessarily a non-recourse state. It depends on the nature of the mortgage, the nature of the way the lender repossesses the house, and a few other things. Short sales are fine as long as you work with a lawyer to make sure the bank provides the proper assurances not to sue you for a deficiency amount. A lawyer can review your financial information and other things to give you an opinion as to what you are facing, if anything.

  3. Lauren says:

    Looking for HELP!! i obviously need to speak with an expert in this area of distressed homeowners to explore my options. I spoke with a lawyer in the past and am now thinking as i near foreclosure i should get another opinion after reading this article & find out what is the best option (Short sale or foreclosure) or keeping it and renting it out again….. !? i was relocated with my job 2 years ago and now live out of state. My home was my primary residence but also was rented at one point as i was living with my boyfriend so i dont know how that will affect this since my tax records will show i wrote off things as a rental home the majority of the time even though i did not own another home, my CPA said that was the best way for tax purposes since i was renting it out. The property is vacant and has been for about 1 1/2 yrs now since the renters moved & i was relocated so i was paying for 2 homes until recently (my residence in Indiana for my job & my vacant home in AZ) and the bills were almost as much as i was making so I stopped payments to cut my losses as i put down 80k on the house and now spent another $30k paying the mortgage for the last 2yrs when i wasnt even living there. It seemed that foreclosure was the best option after i spoke to an attorney bc it was the safest pay to protect myself so that the bank would not come after me to collect the difference. Did i do the right thing? I had realtors calling me tonight wanting to do a short sale with me and im not sure that they are telling me the truth as they obviously want my property to be sold by them even if that means it will hurt me. I thought that AZ being a non-recourse state would save me from the bank coming after me to collect the difference, is that true? If i understand correctly, a short sale does not do much since i have already been deficient . Answers to any of these questions is greatly appreciated!

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