Dumping the “Underwater” Mortgage

You need to sell your house, but you’ve discovered you won’t be able to sell it for enough to cover the mortgage, much less walk away with a profit.  Should you chase the dream of a “short sale?”

Know the truth first!

money-house

You can short sell your home (that is, sell it for less than the value of the mortgage) if your bank agrees.  A short sale, it is said, will preserve your credit score and allow you to avoid bankruptcy.  But be warned:  The short sale has many pitfalls:

  • How good is your relationship with your bank?  Short sales would seem to be a good deal for everyone; the bank recovers at least some of their mortgage as opposed to losing all of it as they would if you were forced into bankruptcy… but in keeping with the unhelpful trends in banking, approvals for a short sale are few and far between.  And because so many banks move at a glacial pace when it comes to helping their customers, you might find a potential buyer for your house, submit the bank paperwork for a short sale, and not find out that you were denied for months – by which point your buyer has long since moved on.
  • Will the bank verify that the short sale will entirely clear your debt?  Make sure of this point; former homeowners have been astonished to discover that even though their bank approved a short sale, they were then sued anyway for the balance, via a “deficiency judgment.”  This nightmare is even more likely to occur if you had a home equity line (HELOC) in addition to your mortgage.  You can find a more complete explanation on the CNN Money website; click here: You Lost Your House But You Still Have to Pay.
  • What is the actual effect of a short sale on your credit rating?  We know that declaring bankruptcy is brutal to the credit score – so arranging a short sale (and thereby recovering at least a portion of the money you owe through your mortgage) ought to earn you a little respect from credit institutions.  Alas, your honorable efforts at not abandoning the obligation of your mortgage might just count for nothing.  The Washington Post ran a good article on this; read this link for more:  Short Sellers May Take a Big Hit On Their Credit Scores .

The myth of the short sale is tempting; the truth is much more ugly – as many an unhappy former homeowner has discovered.  Learn from what they went through, avoid the traps… and consider the bankruptcy alternative:

  • A bankruptcy isn’t as hard on your credit score long-term. Startling but true:  Nothing will get you to a good credit score faster than a bankruptcy discharge.  You can have a solid rating within three years… and because your score is determined by your debt-to-income ratio, having no debt at all during those three years sure doesn’t hurt.  Keep in mind that by the time you get to the point of considering a short sale, your credit rating probably isn’t very good anyway – so the bankruptcy can provide you with a surprisingly clean re-boot.
  • A bankruptcy happens once; the pain of a short sale can go on and on.  Remember that glacial pace the banks move at; they might not decide to sue you for the balance on a short sale until long after you assumed your mortgage debt was settled.  Their suit will once again devastate your credit score.
  • Out-of-pocket expenses for a bankruptcy are cheaper.  If your bank sues you for a deficiency judgment on a short sale, there isn’t much any attorney can do for you; you’re going to end up owing the balance of your mortgage on a house you no longer own and pay that same lawyer to take you through a bankruptcy.  It’s far less costly.
  • Filing for bankruptcy now, while you are in financial trouble, often provides benefits you might not qualify for later.  When you’re dealing with a tough situation – a job loss, a divorce, or an equivalent upheaval in your life – you can often qualify for a chapter 7 discharge on a bankruptcy, which provides you with useful benefits.  But because banks can decide to sue you years after you short sell your house, they may go after you when your finances have recovered.  At that time, a chapter 7 discharge may no longer be an option for you and the results will be much more severe.

The very idea of bankruptcy sounds like failure, emotionally – and the concept of a short sale seems honorable.  But don’t be the sucker that falls for it.  (And if you’re determined, make sure you hire a lawyer; your realtor is not equipped to protect you.)  We don’t write the rules; we just make sure you know how the rules are stacked against you.  Arm yourself with the truth:  Short sales are trouble.

For excellent advice on this topic, Graine Mediation refers clients to: http://www.brandtlawfirm.com, a law firm that focuses on bankruptcy work.

Posted by Prudence Bovee, Guest Writer and Robin Graine, JD, Virginia Supreme Court Certified Mediator

This blog and its materials have been prepared by Graine Mediation for informational purposes only and are not intended to be, are not, and should not be regarded as, legal advice.  This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship.  Internet subscribers and online readers should not act upon this information without seeking professional counsel.

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