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 lender a deed in lieu of foreclosure.
- Allow the property to go into foreclosure.
- Declare bankruptcy.
1. Make payments to reinstate the loan and keep the property.
Lenders often will permit a borrower to make a payment that covers all of the late payments. A homeowner facing default should consider borrowing money from a family member or other lender.
2. 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 borrower 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 some cases, the hazard insurance company may pay the shortfall if there was damage to the premises covered by the policy.
3. 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.
4. 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.
5. Rent the property and move to a more affordable residence.
Many Americans have become involuntary 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.
6. 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.
7. 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. The property is sold at a publicly advertised foreclosure sale or transferred to the mortgage lender if there are no sufficient bids. This situation is considered to be the most damaging to a borrower’s credit.4 Some attorneys may advise their homeowner clients to stop paying the mortgage and live for free in the house until the foreclosure sale. 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. Remember: 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.
8. Declare bankruptcy.
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 a client to pursue this course of action. Some bankruptcy actions will eliminate the debt but the lien will still remain until the owner attempts to sell the property. At that time, it is possible the lender may expect some money to release the lien.
What is Bankruptcy?
Bankruptcy is the financial inability to pay one’s debts when they are due. Bankruptcy is a federal court procedure for individuals who are unable to pay their debts to settle those debts under a judge’s supervision. Bankruptcy is not the same as insolvency. The filing of a bankruptcy case temporarily stops foreclosure proceedings.
Chapter 13 Bankruptcy allows for debt reorganization. The debtor has enough disposable income to submit a reasonable debt payment plan to the court. The plan describes how the creditors will be repaid over a three to five-year period. During Chapter 13 Bankruptcy, the creditors are not allowed to collect on the debtor’s previously incurred debt except via the court. In general, the person is permitted to keep their property and the creditors end up with less money than the full balance of what is owed.
Chapter 7 Bankruptcy allows for a debtor to keep certain exempt property. Some liens, including mortgages, survive bankruptcy. Other assets are sold to pay the creditors. If the mortgage lender’s interests are not adequately protected, the court may allow the foreclosure proceedings to continue.
Bankruptcy will not stop a foreclosure action; it will only delay it. When a person declares bankruptcy, their mortgage lender (as well as other creditors) must stop collection activities for the moment. If a house is worth less than the total mortgage balance, the bankruptcy trustee assigned to oversee the distribution of assets will eventually realize that there is no equity in the property. In many cases, they will release the real estate from bankruptcy, and at that time the mortgage lender can continue with a foreclosure action.
A homeowner who is seriously delinquent on their mortgage could declare bankruptcy shortly before the foreclosure action to essentially buy more time in the home. Declaring bankruptcy may be a good course of action for someone who has multiple delinquent debts and insufficient income to cover all those obligations. A person considering this should definitely speak with a bankruptcy attorney.
