When Your Debt Exceeds Your Home Value

One option to consider is called a short pay off. Chris Colvin offers this Q&A on short pay offs.

• What is a short pay off?
  Imagine your home is worth $200,000, but you owe $220,000 on it. If you were to sell it in the open market at $200,000, you might net $184,000, or $36,000 less than what you need to pay off the loan. A short pay off is where your lender will forgive a portion or all of the short amount.
• What lender would just write off that type of money?
  Just about all of them will, with justification. Justification might mean a substantial loss of income that would prevent you from paying on the mortgage, therefore being forced in a position to sell the home. Attempting to sell short so you can upgrade to a larger property is not justification. In addition, lack of cash reserves will also serve as justification. Don't expect to place your home on the market at 75% of market value and expect your lender to jump on any offers.
• How will this affect my credit?
  Depending on how you negotiate the transaction, it could go on your credit report as, "settled," or, "paid," or "short payoff." It depends on the lender and how well you can negotiate.
• Are some lenders harder to deal with than others?
  Yes. If you have a Freddie Mac loan, Freddie Mac will probably want you to contribute to the short sale, get your agent to reduce brokerage fees, and get the buyer to take the property with the termites. Some lenders will just ignore you.
• What will my lender require from me in order to consider participating in a short sale?
  Packaging is very important. When you place the property on the market (go with an agent), your agent should send the lender the following:
  
  1. Your past 2 years tax returns
  2. Letter of hardship
  3. Complete loan application
  4. Preliminary title report
  5. Listing contract
  6. Copy of MLS
  7. A marketing plan for your home
  8. A broker price opinion (like an appraisal).

  When you have an offer, all of the above should be enclosed with the offer (except for the marketing plan) plus the purchase agreement, and a good faith estimate as to what the lender will net after the close of escrow.

• Why should I list with an agent? It seems if I can save the brokerage fee that the lender would net more and be more inclined to accept any offers that come in.
  You are correct. If you're loan is current, you may be able to get a qualified buyer yourself. If your loan is delinquent, or in default, you don't have time to play around getting your home sold. You need as much exposure as possible.
• What happens if my lender say's "No," and I'm in foreclosure?
  This is one situation where "No," means, "Maybe, you just haven't convinced me that participating in a short sale is to my benefit." Keep hammering your lender, and do not take your home off the market until your lender agrees to a sales price and the prospective buyer has formal loan approval.
• Should I try to hide any assets in order for the lender to consider participating?
  Most assets are traceable, except for personal collections (guns, coins, etc.). If you own another property, it will show up on your credit report. Your lender may back track to your original loan application to see if there are any other assets. No, don't hide assets. If your lender discovers you're not dealing honestly, they'll never co-operate.
• Can any real estate agent or attorney handle a short sale?
  A lot will say they can. There's no real way to tell if they can. If your home goes into foreclosure, you'll get flooded with a ton of mail. There's a good bet that most of the mail is from people who have helped out previously in these situations. One way to tell is if the person you're dealing with will ask you for the information outlined above. They'll know these are the requirements.
• Question: I believe that in California, the loan is secured by the property, so the bank cannot go after your assets to make you pay the remaining balance of the loan. The bank will try and guilt you into doing so, ignore them. If they refused, threaten to foreclose and be ready for the bank to do so. At that point, they will usually negotiate. I'm sure this info won't be added to the real estate critter's FAQ.
  Actually, this is a good example of a misnomer in the foreclosure arena so this "real estate critter" is going to add it to the FAQ. There are no deficiency rights in California for Purchase Money Loans. This is the loan you obtained in order to purchase the property. Once you refinance the property, take out an equity line of credit, obtain a consumer loan that is secured by the property, this rule no longer applies. The lender has the right to go after you in a deficiency judgment, even if a senior lien holder takes the property back and a junior loses his security instrument.
• How can I assure a non-purchase money lender won't go after me after the short sale?
  When any lender agrees to a short pay, they are relinquishing their right to pursue the borrower in the future.
• Are there any tax ramifications?
  Yes. According to IRS Section 108 a-e, there are debt/income interpretations that may come into play. The IRS may view the deficiency on a non-purchase money loan as income and demand you to pay taxes on that amount. If the short pay transaction resulted in a net loss of $20,000 to the lender, your tax liability could be around $6,350.
• So why would I want to do a short sale only to owe the IRS money?
  To limit your tax liability. In some cases (not Citicorp, Fannie Mae, or Freddie Mac) the senior lien holder will allow for some funds to be allocated to the juniors. If you allow the property to go into foreclosure, and the juniors lose 100% of their money, you can get taxed on the full amount. You should really contact a CPA concerning this part of the Tax Code.
• I have an FHA loan. They won't do a short pay. Any suggestions?
  Any feedback from other states would be appreciated. There are certain regions where FHA will not participate in short sales. One region is the state of California. If you are in foreclosure on an FHA loan in California, you may want to approach HUD to see if they will consider a lower interest rate, or some type of repayment schedule until you get back on your feet.

If you have any further questions that can be added to this FAQ, please send them to: Chris Colvin at Chris Colvin

Chris Colvin is a San Francisco Bay Area real estate professional.