What are the alternatives to a short sale?
A short sale may have legal, credit, and/or tax consequences. There are several alternatives to a short sale. These other options include:
- Make payments to reinstate the loan and keep the property.
- Sell the property and bring cash to close escrow.
- Attempt a workout with the lender.
- Assumption of the mortgage by a buyer.
- Rent the property and move to a more affordable residence.
- Offer the bank a deed in lieu of foreclosure.
- Allow the property to go into foreclosure.
- Declare bankruptcy.
Make Payments to Reinstate the Loan and Keep the Property
Banks often will permit a borrower to making a payment that covers all of the late payments. A person facing default should consider borrowing money from a friend, family member or other lender.
Sell the Property and Bring Cash to Close Escrow
This is known as a make-whole pre-foreclosure sale. The lender does not sustain a loss. The shortfall is paid by the seller at closing. For example, if a borrower owes $100,000, and the proceeds of the sale generate only $95,000 for the lender, then the borrower can contribute $5,000 at settlement. Alternately, the private mortgage insurer (PMI) may pay the shortfall. In rare cases, the homeowners insurance company may pay the shortfall if there was damage to the premises covered by the policy.
Attempt a Workout With the Lender
Homeowners are encouraged to work with the lender to forbear the loan, develop a repayment plan, or modify the loan. A forbearance plan is one in which the lender permits a partial payment or a skipped payment if the borrower has an acceptable plan to catch up on the payments. A repayment plan is one in which the lender allows the borrower to pay an additional amount each month until they catch up. A loan modification is a permanent change to the terms of the note. Loan modification plans include:
– Requiring that property taxes and insurance be included with the monthly payment so the borrower can avoid big bills throughout the year.
– Adding all the missed payments to the loan amount and increasing the monthly payment to cover the bigger loan.
– Switching from an adjustable interest rate to a fixed rate to create stability for the homeowner.
– Lowering the monthly payment by adding years onto the duration of the loan, lowering the interest rate, and/or forgiving some of the loan balance.
Assumption of the Mortgage by a Buyer
The lender may allow a buyer to assume the mortgage. The lender will determine if the buyer is qualified to handle the monthly debt obligations. Lenders often charge a processing fee to evaluate whether to permit an assumption, and in many cases a new appraisal must be paid for by the buyer and/or original borrower. The lender may require that the original borrower still remain personally liable for the loan should the buyer default on the payments. Assumptions are more common with commercial loans these days.
Rent the Property and Move to a More Affordable Residence.
Many Americans have become accidental landlords, as they’ve been forced to rent their property to generate money to pay the mortgage loan. This is a good move for a borrower if a suitable tenant is found who can afford a reasonable rent. In some cases, the rent will not cover the entire monthly payment, leaving the borrower to pay some money out of pocket to keep the mortgage current. However, this is typically less painful for a borrower. Ultimately, market rents may increase to an amount whereby the borrower does not have to come out of pocket to make the monthly mortgage payments. Alternately, the real estate market may improve with time, allowing the borrower to eventually sell the property for more.
Offer the Lender a Deed in Lieu of Foreclosure
This is known as a “friendly foreclosure.” The homeowner voluntarily conveys clear property title to the lender in exchange for the discharge of the debt. A lender might consider a deed in lieu of foreclosure if the following occurs:
– The lender determines that the borrower faces an involuntary hardship that creates a long-term inability to pay.
– The borrower is cooperative by communicating with the lender and allowing complete access to the property for the lender’s inspection and appraisal.
– The borrower is delinquent or faces default.
– The lender sees that the homeowner made a good faith effort to sell the property but was unable to do so.
Allow the Property to Go Into Foreclosure
In this situation, the homeowner either gives up or fails in all other attempts to resolve the situation. In states with a judicial foreclosure process, the property is sold at a Sheriff’s Sale. In states with a non-judicial process, the bank can take the property back without a foreclosure auction. Foreclosure is considered to be the most damaging to a borrower’s credit. Some attorneys may advise their homeowner clients to stop paying the mortgage and live for free in the house until the foreclosure occurs. This course of action is often the last resort, given that the homeowner has exhausted all other measures to prevent the foreclosure action. By living in the house until the very end, the borrower does not have to pay rent elsewhere. In such cases, the borrower saves the money that they would have paid the lender so they can have enough to rent a home when the time comes. Only an attorney or accountant familiar with bankruptcy and foreclosure situations should advise a client to stop paying their mortgage. There are serious consequences to this course of action for borrowers.
A bankruptcy typically does not prevent a foreclosure action, but it will delay it. Only a bankruptcy attorney or accountant familiar with bankruptcy should advise someone to pursue this course of action.