You’ve got a piece of property, whether it be a primary residence or an investment property, and cannot make the payments, or are at a minimum having trouble making payments. Other than a short sale, what are your other options? What are the pros and cons of each?
1. Short Sale - The focus of this blog. You can find information here regarding the documents and information necessary to complete (or even propose) a short sale. Collecting this information can be a lengthy, cumbersome and potentially expensive process. Plus, there is no guarantee that you will find a buyer - or that the buyer’s offer will be approved.
Tax implications: In a short sale, you will receive a 1099 (miscellaneous income tax form) for “cancellation of indebtedness income,” thanks to Internal Revenue Code section 61(a)(12). If you do not know what the term “deficiency” means, check the first post for a discussion of this term. The amount of the 1099 will be equal to the deficiency. If the property sold is your primary residence, then you have a tax break for tax years 2008 through 2012. If it is invesment property, you should begin gathering information to make your case for “insolvency” - assets less than debts (see another post on this blog titled “Making the Case for Insolvency”). This is measured at the time of the transaction. Otherwise, you will be taxed at ordinary income rates on the deficiency amount.
Credit Impact: In the spectrum of the three options presented here, the short sale has the smallest impact on your credit score. However, this has been described as the difference between “being hit by a truck and being hit by a train” - in the end, we’re really talking about distinctions that may have no practical difference.
2. Deed in Lieu of Foreclosure: You can ask the bank to consider taking title to your property without going through a formal foreclosure process. The requirements for this process are very similar to the requirements for a short sale (see “What is the Short Sale Process?” in this blog). So, you may have very similar costs, with no guarantee that the lender will approve the deed in lieu. From the lender’s perspecitve, they want to intimidate you enough to make sure that if you have the money, you’re paying your loan - where I come from, they call this “trying to get blood from a turnip.” (I’m from Missouri, by the way) In my experience, the lender may also ask you for either a cash contribution or to sign a promissory note. Now, the terms on the promissory note are very favorable, and it is unsecured, but it sure doesn’t provide much inceitive to go this route.
Tax implications: Lenders will provide you with a 1099 (see above) for the difference between the amount of the mortgage and their own estimate of value (established bya BPO - see previous posts for explanation of this acronym). Again, if this is a primary residence, you’re likely OK. If not, you need to get with your accountant before the transaction to tax plan for making the case for insolvency.
Credit Impact: In the spectrum of the three options presented here, this is the middle ground. Not as significant of an impact as foreclosure, less than a short sale, but still pretty large.
3. Foreclosure: This might be the simplest, most straight-forward and least labor-intensive option available. You stop paying your loan, the bank sends a multitude of nasty letters demanding that you pay the amounts owed, and eventually they turn the file over to an attorney to foreclose. In this environment, I have worked with clients who are over 120 days delinquent on their mortgage, and foreclosure has still not started. The length of the foreclosure process will depend completely on your own unique state laws. In Colorado, the lender has to wait approximately 120 days after filing foreclosure to execute a “foreclosure sale.” The sale consummates the foreclosure, and typically (if there are no 3rd party bidders), the bank buys the property at the sale. You will likely want to move out before foreclosure. If you do not, the bank will have to file another action to evict you.
Tax implications: Same as the above 2, except that you will receive a 1099 for the entire amount of your mortgage.
Credit Implications: The worst of the three here. This is not as bad as bankruptcy, but you should expect to recover in no shorter time than 3 to 5 years.
Depending on your specific circumstances, one of these options is likely best.