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What Are My Options if a Lender Rejects a Short Sale?

What are my options if a lender rejects a short sale?

I had a buyer for my investment property through a short sale. After waiting for about 5 months the sale fell through. The buyer was very dissapointed. The bank had forgiven any debt for the condo assuming that the sale would close. My realtor is going to put the property back on the market(cash only)to see what happens. What should I do and what are my options. I just want this whole situation to be over with. Thank you Joel

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Editor’s note: See the Bills.com resource Home Affordable Foreclosure Alternatives Program for an updated discussion of deeds in lieu of foreclosure and short sales.

It sounds to me that you are going about it the right way. Doing a short sale is typically a much more preferable option, rather than going through a foreclosure. Another option is a deed in lieu of foreclosure. A deed in lieu of foreclosure and a short sale are very similar but there are some key differences that depend on the details of the situation.

What is a Deed in Lieu of Foreclosure?

As mentioned, a deed in lieu of foreclosure is an alternative to foreclosure. In a deed in lieu of foreclosure, the property owner gives the property to the lender voluntarily in exchange for the lender canceling the loan. The item transferred is the deed to the property. The lender promises not to initiate foreclosure proceedings, and to terminate any foreclosure proceedings already underway. The lender may or may not agree to forgive any deficiency balance that results from the sale of the property.

An overlooked downside to a deed in lieu of foreclosure is the possible forgiveness of the deficiency balance. Under federal law, a creditor is required to file a 1099C whenever it forgives a loan balance greater than $600. This may create a tax liability for the former property owner because it is considered "income." However, the Mortgage Forgiveness Debt Relief Act of 2007 provides tax relief for some loans forgiven in 2007 through 2012. See the IRS document "The Mortgage Forgiveness Debt Relief Act and Debt Cancellation."

The key issue in a deed in lieu of foreclosure is whether the lender is willing to forgive the deficiency balance. Read the contract carefully to see how the deficiency balance issue is handled. If the document is unclear, take it to an attorney with experience in property law. An attorney's time is not cheap, but will be a bargain compared to signing an agreement you do not understand and are surprised later to realize its implications.

Here is the typical (although by no means exhaustive) list of short sale requirements: a) the residence must already be on the market for a certain number of days (90 days is typical), b) there can be no liens on the property, c) the property cannot already be in foreclosure, d) the offer of a deed in lieu must be voluntary, e) for a short-sale, the seller must have a hardship, f) the house must be priced reasonably.

Is a ‘Short Sale’ a Better Option?

On the other hand, the property owner and lender may choose to do a short sale on the home. Through a short sale the lender agrees to accept less than the balance owed on the mortgage at sale. The deficiency balance is forgiven, typically.

However, recently Bills.com readers have reported that some mortgage companies are asking borrowers to agree to accept liability for the deficiency balance. The lesson here is if you are considering either a deed in lieu of foreclosure or a short sale you must review the terms and conditions carefully and make certain you understand whether the deficiency balance is forgiven.

Unlike a deed in lieu of foreclosure, the ownership of the property is not transferred to the mortgage holder, and remains with the owner.

Some lenders choose short sales because they do not want to own the distressed property. They would much rather see the owner sell the property and lose the deficiency balance than be forced to take the property through foreclosure, as foreclosure is a costly and time-consuming process.

Whether the lender picks a deed in lieu of foreclosure or a short sale depends on how the lender balances its risks and how it wants the distressed properties to appear on their books. Local laws may have an impact on the decision, too.

One last point regarding short sales: Like deeds in lieu of foreclosure, a lender is required to file a 1099C if the debt forgiven exceeds $600. As mentioned in the deed in lieu of foreclosure section above, The Mortgage Forgiveness Debt Relief Act offers former homeowners relief for forgiven debt.

What if the Lender Rejects a Short Sale or a Deed in Lieu of Foreclosure?

If the lender will not allow a short sale or a deed in lieu of foreclosure, foreclosure is the last option, although it presents major problems. Foreclosure auctions tend to bring significantly less money than a normal sale would bring. If the sale brings less than the amount owed on the loan, the remaining balance of the loan is called a deficiency balance.

If the home falls into foreclosure, it is possible to mitigate the negative impact of a deficiency balance by filing bankruptcy. Generally speaking, deficiency balances are treated like any other unsecured debt in bankruptcy, meaning that they can be wiped clear by Chapter 7, and repaid over time through a Chapter 13. Although bankruptcy does not sound like a positive alternative, it may be the best solution if the mortgage lender will not allow the home to be sold through a short sale or a deed in lieu of foreclosure.

Lastly, I urge you to consult with an attorney experienced in bankruptcy law to understand all of your options to resolving your mortgage debt.

I hope this information helps you Find. Learn & Save.

Best,

Bill

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4 Comments

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  • KS
    Mar, 2012
    Kay Kay
    Chambersburg, PA
    Bill, We are 3 months behind on our house payments, we have submitted a payment modification it was declined. Do we wait for a few months and see if lender wants to work with us to avoid foreclosure. Or start short sale procedures asap? Are they more likely to forgive balance if we continue the payments? Thanks Bill
    0 Votes

    • BA
      Mar, 2012
      Bill
      Without knowing more about your situation, it is difficult to comment meaningfully.

      I doubt waiting will accomplish anything positive. Consult with a lawyer in your state who has experience in negotiating with mortgage servicers. You may be in a position to modify your loan (if your loan is underwater) or otherwise change the terms to be more favorable for you.
      0 Votes

  • BA
    Mar, 2010
    Bill
    Protecting your liquid assets and your retirement plans in this situation is very serious matter and your best course of action will depend on numerous particulars unique to your specific situation. I highly recommend that you find a qualified financial adviser to help you with something as important as this. I suggest you do some homework: get referrals (from family, friends, co-workers, reputable industry groups, and Web sites you trust), check for certifications, learn about the different fee structures, and have face-to-face interviews with as many financial professionals as you need to until you find someone or a company you trust and are comfortable with. You will find a longer article I wrote on how to go about choosing a financial planner at http://www.bills.com/help-with-financial-planning/.
    0 Votes

  • TP
    Mar, 2010
    Terri
    Hello Bill, I applied for a loan modifications at Citi and they put me on a four month forbearance. This is great but it has a balloon payment. I have high liquid assets and I am afraid I will not qualify for the modification because of this. Why should I be penalized for saving my money? I want to use this for my retirement. My income is down 75% and all I want is a fixed loan I can afford. How do I get this with money in the bank??
    0 Votes

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