Short Sales and Deeds in Lieu of Foreclosure
You might be able to avoid a foreclosure by arranging for a short sale or a deed in lieu of foreclosure. Either of these options can help you prevent the lender from pursuing a deficiency judgment against you. A deficiency judgment is when the foreclosure sale fails to generate enough funds to pay off the balance on the loan, and the lender pursues the borrower for the remainder. However, both short sales and deeds in lieu of foreclosure have certain drawbacks of which you should be aware.
Understanding Short Sales
A short sale involves agreeing with the lender to sell your home for a price less than the remaining balance on your loan. This is similar to a foreclosure sale except that the lender agrees to refrain from pursuing you for any deficiency. Some states prohibit deficiency judgments after short sales by law, while borrowers in other states must arrange with the lender to waive the deficiency.
Deficiency Judgment After a Short Sale in Connecticut
A “short sale” is when you sell your home for less than your total mortgage debt, and the proceeds of the sale pay off a portion of the balance. In Connecticut, the bank can get a deficiency judgment after a short sale.
To avoid a deficiency judgment, a short sale agreement must expressly state that the bank waives its right to the deficiency. If the short sale agreement doesn’t contain this waiver, the bank may file a lawsuit to get a deficiency judgment. Though, if the bank forgives the deficiency, you might face tax consequences.
In Connecticut, if the foreclosure sale price doesn’t cover the balance of your mortgage loan, the lender can come after you for the “deficiency.”
Drawbacks of Short Sales
If you have taken out multiple mortgages to refinance your home, you must get those lenders to agree to the short sale as well. There is no reason for them to agree because they get nothing out of the short sale, so people with multiple mortgages usually cannot use this option.
You cannot propose a short sale unless you have a bona fide offer from a potential buyer that you can present to the lender. This can be challenging because neither the buyer nor you will be able to foresee what the lender will demand, so a buyer may be reluctant to make an offer.
The IRS considers forgiven debt, such as a deficiency waived by a lender, to be taxable income. This may increase your tax liability and put further stress on your finances. If you are legally insolvent at the time of the short sale, though, you will not need to pay tax based on the deficiency. Legal insolvency means that your total debts are greater than your total assets. The Mortgage Loan Forgiveness Debt Relief Act also provides some exceptions for loans made between 2007 and 2017.
Understanding Deeds in Lieu of Foreclosure
A deed in lieu of foreclosure is different from a short sale because it transfers the property to the lender instead of selling it to a new buyer. The homeowner should get the lender to agree to refrain from starting a foreclosure (or to terminate any existing foreclosure) and to waive any deficiency based on the sale price of the home. Most lenders find this option less appealing than a short sale because they will need to handle the logistics of the sale instead of the homeowner. However, if you list your home for sale and cannot sell it after a few months, the lender may accept a deed in lieu of foreclosure.
Similar to a short sale, a deed in lieu of foreclosure likely will not damage your credit as severely as a foreclosure or a bankruptcy. As noted above, the burden of selling your home shifts to someone else, so it may be more appealing than a short sale.
Drawbacks of Deeds in Lieu of Foreclosure
A deed in lieu of foreclosure shares some of the same disadvantages as a short sale. This option probably is not available if you have additional mortgages or liens on the property. It also can have negative tax consequences because it leads to a “forgiven debt.” Exceptions to tax liability are the same as those for short sales.
During a period with a high rate of foreclosures, a lender may find a deed in lieu of foreclosure less attractive than a short sale or a foreclosure because it would prefer money rather than property. (However, it does avoid foreclosure costs by accepting this alternative.)
THE GOOD NEWS is:
Steve Schappert is Here
Steve Schappert gets involved in short sales, where the sales price agreed upon is less than that owed to lenders by the seller. He is often called upon to communicate between your lender/servicer and you regarding financial obligations. He is fully aware of laws regulating the activities of those who assist homeowners, laws beyond those that govern real estate brokerage activities.
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