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January 7, 2008

Short sales avert foreclosure, but still have pitfalls

The process means houses are sold for less than what is owed on the mortgage.

Your adjustable-rate mortgage has reset and you can’t make afford the higher monthly payments. In a sluggish real estate market, the property isn’t worth the same as the day you bought it.

For homeowners and lenders who share a devalued asset, the answer may be a short sale.

Short sales are deals between borrowers and lenders to sell a house for less than what is owed on the mortgage. Some in the real estate business expect their numbers to grow.

The growth of foreclosures has been attributed to the increase in adjustable-rate subprime mortgages. Such loans allowed people with less than perfect credit to buy property. Those resets are pricing some homeowners out of their houses.

For the homeowner, short sales avert a foreclosure process that can damage their credit record. Travis Olsen, president and principal partner of the National Short Sale Center in Scottsdale, Ariz., said foreclosure histories can keep someone from obtaining new credit to buy another house for up to10 years.

But short sales aren’t perfect solutions for consumers because they can still reduce a credit score by 75 to 100 points, said Burt M. Hoffman, a Stamford, Conn., attorney. Short sales are a growing part of his practice.

Lenders will consider such sales as an alternative to foreclosure because the latter process is time-consuming and costly, Olsen said.

For example, banks in New York can lose up to half of the mortgage’s value in foreclosure because the process can take up to 280 days. Interest payments go uncollected, unpaid taxes pile up a lawyers and real estate agents must be compensated. Disgruntled homeowners in arrears may let the property’s condition slide or damage the property out of spite or frustration.

Selling a property short of what’s owed on the mortgage can get an unproductive asset off an investor’s balance sheet quickly.

There are conditions for doing such a deal, Olsen said. The borrower must be unable to pay the existing mortgage, and the property must be worth less than the borrowed amount.

Homeowners walk away from short sales with nothing, and often less than that. The house is worth less than what they bought it for, so they’ve lost the closing costs and any equity in the property that might have existed.

There also may be tax implications. The IRS treats the difference between what the homeowner borrowed and what the lender accepted to settle the mortgage as income to the homeowner.

That difference can add up to tens of thousands of dollars, and the homeowner will be expected to pay taxes on that amount.

Congress is debating legislation that would reduce such penalties.

Not all lenders will accept short sales as a complete solution to the debt owed. Hoffman said a few banks want promissory notes from borrowers that require them to pay the full amount of the mortgage even after the short sale has been closed.

Short sales have “a lot of moving parts,” Hoffman said. “It’s a very tough deal to work. You have got to do it properly.”

 

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