Foreclosure versus Short Sale – Just Shades of Gray?

If you own real estate that is “upside down”, “underwater”, has “negative equity”, or is worth  less than you owe your mortgage company on the property . . . . . if  you are still burning through your savings, retirement, and other assets to continue making the mortgage payment, let us review:

Your 5 main options:  (1) Sell the house and use everything you own now, or can beg from friends and family, or everything you can make  for the next twenty years to pay off the lender what you owe;  (2)  Give the lender the house;   (3)  Get your loan(s) modified or see if there are any government programs that can help;  (4) Just quit making payments, save your money, and live in the house until you are kicked out;  and (5) Short Sell the house.

There are of course other less well known options.  I had a client ask today:  “can I put my kids on title to my upside down house to get them to help pay for it so that there will be something left to inherit when I die?”    I thought for a moment and then diplomatically tried to explain that as an investment for future equity, the kids could find a much better return  for their money.  Real Estate with equity, for example.   On the other hand,  just being on title with their mom might not make a difference if the real reason the kids were helping to pay mom’s mortgage was so that  their mom would not become homeless and need to move in with the kids . . . .    But before I digress into further speculation, let us refocus.

Today’s post is to help the homeowner walking the tightrope of financial distress with no safety net (and no kids with the ability and willingness  to bail out their parents).  I will assume you’ve read some or our previous blogs on “deeds in lieu” of foreclosure (2), the challenges of modifications (3), and you just are not feeling generous enough to do the first option above.  (1) above was once considered noble, but when you think about it, there is potentially more benefit to the U. S. mortgage lending industry to have a million former homeowners in America who are also potential future homeowners than it is to have a million additional homeless people wandering the streets and dragging down home values.

So for most people it still comes down to (4) or (5).   Psychology and fatigue still drive far, far too many homeowners to the abyss of foreclosure.   Denial, wishful thinking, lack of good counsel, embarrassment, hopelessness, depression, divorce, unemployment or underemployment are just a few of the factors that lead homeowners to see themselves as victims and helpless to accomplish anything better than foreclosure as the final chapter of their home ownership lives.

There IS hope, including of course,  an encouraging foreclosure prevention consultation with this law firm.  You just need to reach out!   If all you need to shock you out of the lethargy of helplessness is a little more motivation, here it is –  THREE REASONS TO WORK FOR A SHORT SALE TO PREVENT A FORECLOSURE:

1.  The IRS.  Whether your adventure in home ownership ends in Foreclosure or Short Sale, the lender will give you a 1099C.  In a Foreclosure, the amount of written off debt is generally imputed to you as income!  You get taxed on it!  In a Short Sale involving your primary residence, at least for the remainder of 2013, there are laws that protect you from this “phantom income.”

2.  Credit Damage.   I’ve heard bankruptcy experts and others (often with more than a little self-interest) downplay  the difference in credit damage from Foreclosure versus Short Sale.   In an abstract way, if you could compare the two, there may be just shades of gray.   But for most mortgage loans, Foreclosure follows at least three missed mortgage payments!  That in and of itself adds 100 points of damage to your credit score!  It is entirely possible in a Short Sale, if planned in a proactive way, to occur after NO MISSED MORTGAGE PAYMENTS!   So ignore the abstract advice!  The majority of experts agree, the average person emerging from Foreclosure is going to have a 60 to 150 point deeper loss of credit than the average person emerging from a Short Sale!

3.  Future Poverty.  Your lender(s) will very likely amass a greater amount of unpaid debt, a/k/a a “deficiency”, that you owe if you go through Foreclosure rather than if you Short Sell your property.  In a Short Sale, you, your realtor, and your lawyer as SSN (short sale negotiator) will help maintain control over the sale of the property and to make sure no one takes advantage of you or “steals the property”.  It is an open market sale process that uses time tested tools to attract the best possible offers for your home.   In a Foreclosure, a big slice of your equity will be consumed to help pay for the costs of additional legal fees for the lender, advertising, appraising, inspections, certified mail, etc..   The expense factor varies significantly by state with the most expensive states being “judicial foreclosure states”.   Virginia lenders are generally able to foreclose relatively quickly and cheaply and without going to court, but the costs in Virginia can still exceed in $10,000 in many cases.  That loss is one that you and your lender share and can never recover.   Once your property comes to auction, the Lender faces an awful choice whether to let the property be sold to a third party bidder, often for as little or less than half of the outstanding loan balance that you owe.   The Lender always has the option to bid $1 more than the highest lowball offer and “take the property back”.    In practical terms, that means that after the Foreclosure auction, the Lender owns both your home (now as “REO” or real estate owned) AND  you can still owe them more than half of the outstanding debt!

Ouch!  At this point, you have lost your property, your one negotiating chip, your only element of power and control, and you are still largely in debt.  Unlike in some states, (e.g., California or North Carolina if the home was your primary residence), the lender is not limited to EITHER Foreclose OR  sue you for the money.  Without “election of remedy” laws, Virginians who lose their homes at Foreclosure often have to defend themselves against lawsuits to recover the deficiency, or the difference between what is owed and what is paid or credited to the outstanding mortgage loan balance at auction.

The simple and unfortunate truth is that Foreclosure Auctions simply do not generally garner as much recovery for the Lender(s) as do the fair market sales of a Short Sale.  The minimal advertising requirements of Virginia law and federal loan regulations  do not reach as many potential buyers as would an MLS Listing.  There is usually no FOR SALE sign in the yard prior to a Foreclosure auction.   Potential buyers are not entitled to inspect or even see the interior of the homes in Foreclosure.  The phrase “Pig in a Poke” is often used to describe the process of buying homes in Foreclosure.  Even the successful bidder at a Foreclosure auction may not have access to the inside of the property purchased until months after the “gavel comes down” at the auction if the homeowners refuse to move out and especially if they file bankruptcy.  And homeowners in Foreclosure are not known for taking great care of their properties.    With only the neighborhood and exterior appearance of the property on which to base their bids, many experienced Foreclosure bidders refuse to bid what is often called “stupid money” or more than 45 to 65% of the possible value of the house.   Keeping the Foreclosure auction bid low leaves a greater allowance for rehabilitation money, marketing expenses, unexpected legal expenses, etc..

Another factor that may drive down the recovery to the Lender(s) in foreclosure is “bidder Conspiracy or Collusion”.  According to USA TODAY,  in some states, “real estate speculators were illegally fixing the bidding process.”  While this practice has been more prevalent in California, for example, than in Virginia, never underestimate the impact on Foreclosure bid amounts of the small tight knit community of regular foreclosure bidders even in Hampton Roads or Tidewater, Virginia.

Admittedly, after hours of research, I have failed to find statistical quantification of how much larger the average deficiency is after Foreclosure versus Short Sale.

But, in the final analysis the difference between foreclosure and short sale is NOT  just shades of gray, but succumbing to the F word is like like what Jesus himself called:  “being cast into outer darkness”.    How much more weeping can your eyes take? How much more gnashing can your teeth take?   Let us help you save your eyes, teeth, home, sanity, savings, and self-respect!  Call now for a free consultation!

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