In an earlier post, we explained the process and the potential benefits of a “short sale.”
In the last 10 years, short sales became much more common. Why? The mortgage crisis of 2008-2009 made many homeowners “upside down” or “underwater” in the equity position they held in their homes, i.e., the mortgage loans exceeded (sometime far exceeded) the fair market value of the home. Now, more and more often, these homeowners are also doing short sales to extricate themselves from this unfortunate position. A short sale occurs when the lender or investor agrees to accept an amount less than actually owed on the property. The lender sells the property “short.”
Usually using a real estate agent, the homeowner markets and sells the property. The new buyer usually gets a bargain. The homeowner gets out from under an unmanageable mortgage at transfer of title. They make a clean break. In order to qualify for a short sale, generally speaking, the homeowner must demonstrate a verifiable long-term hardship rendering him unable to pay the mortgage.
So far, this doesn’t sound like such a bad deal. The house I bought loses value, so I sell it at current market rates and the lender takes the loss. The homeowner may even get a relocation allowance from the bank.
Well, true, but every upside has a downside. The homeowner no longer has a home. And, the former homeowner will probably be a renter for several years to come as his credit score will immediately take a plunge. The newest loan guidelines from Fannie Mae and Freddie Mac specify that after a short sale, a prospective borrower must wait for 2 years to qualify for any FHA- or government-backed loan. As well, there may be personal tax consequences for the former homeowner. It can get complicated.
To avoid these complications, a short payoff may be an alternative to a short sale. Like all cases, this option may only be an option depending on your particular circumstances. So, what’s the difference between Short Sale v Short Payoff?
The strict requirements for a short payoff are generally as follows:
- The mortgage must be current.
- The homeowner must have great credit.
- The homeowner must demonstrate the ability to pay off the debt.
What debt? In a short payoff scenario, remember, the lender agrees to accept less than the amount owed on the property to release the lien. However, in return, the homeowner signs a promissory note for the difference or a negotiated difference agreeing to “pay off” this unsecured line of credit according to the terms of the promissory note. The debt they elect to take on as an unsecured debt (like a credit card debt) for the amount less than the total payoff amount at the sale of their home.
So the homeowner sells his house for no profit and takes on debt even after the sale. Hmm…why would a homeowner want to even consider this?
- If the homeowner is underwater by a manageable amount. (This amount is, of course, relative but should be relatively small)
- If the homeowner has the means to pay back this manageable debt (again, like a credit card).
- The homeowner wants to maintain a high credit rating for his or her own personal financial future and move forward from an upside down house.
As you can see, the scenario must be just right for this option to make sense but the point is that all options should be explored.
If you are interested in finding out more about the various options for a distressed homeowner, contact our office at 718-539-1100 or email us at email@example.com.