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.
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.