Selling Short: A Beginner’s Guide to Avoiding Foreclosure and Bankruptcy
Struggling homeowners who cannot keep up with mortgage payments have few choices when faced with the realities of job loss or other financial hardships which make it difficult or even impossible to pay their mortgage. Generally, there are three options: (1) Bankruptcy, (2) Foreclosure or (3) Short Selling. All three options have negative effects on a consumers credit rating, but generally bankruptcy and foreclosure have a far worse and longer impact than a successful short sale.
Bankruptcy is a federal law that permits an individual to start over with a “clean slate” of debt. Essentially the debtor surrenders her assets, less certain household and personal exemptions, and those assets are used to payoff creditors for less than what is owed. The debtor is then legally relieved of the debts, and can start over. Foreclosure occurs when a homeowner defaults on mortgage payments and the bank “forecloses” its security interest in the property – the mortgage – and the property ownership is transferred to the creditor bank for resale and satisfaction of the secured debt. Both bankruptcy and foreclosure have devastating effects on homeowners credit ratings, and it can take many years for the borrowers credit rating to recover.
Short selling, on the other hand, requires no legal action such as a bankruptcy filing or a foreclosure proceeding. Typically, a homeowner who cannot continue to make payments or who needs to sell reaches out to the bank that lent the money to buy the house and request “forgiveness” of a portion of the principal owed in order to facilitate a sale. The homeowner does not necessarily have to be in arrears on the payments for the house, but often times the reality is the bank will not entertain the short sale unless there are arrears.
The process of short selling keeps the seller in control, somewhat, with the seller choosing a broker and lawyer to represent them in the sale, and then marketing the property to the public. It is important that sellers disclose to potential buyers who are interested in pursuing a deal that the sale will require third-party approval (e.g. the bank) and that can take time. Not all buyers have the flexibility or temperament for a short sale which can take months longer than a typical sale.
But when a willing buyer is found, the seller’s counsel drafts the contract of sale and makes it contingent upon the bank’s approval. Once the contract is signed, it is submitted to the bank with additional documentation demonstrating the seller’s inability to pay and financial hardship. The proposed sale is reviewed by a “negotiator” at the bank, who often times request various vendors and homeowner creditors (such as a condominium association) to reduce their fees in order to make the deal more palatable to the creditor bank. Once everyone is in agreement, the sale can proceed, and the mortgage, even though not paid in full due to the shortfall in proceeds, is extinguished and the homeowner relieved of any further obligations on the sale.
Short selling is not for everyone, but the process can be a lifeline to homeowners who find themselves in financial hardship and inability to pay their mortgage payments.