Short Sale Distress: Know When to Hold or Fold
If you know 10 people who own homes, at least two or three of those are probably "under water." No, I’m not talking about the flooding in Australia. Instead, I’m referring to homes that are worth less than the owner owes on his mortgage (or has paid for the home, if it was a cash purchase).
Homeowners who are under water have a few options:
- Continue to live in the home and pay the mortgage in hopes that the home’s value will increase
- Sell the home at a loss (known as a short sale with or without the bank’s approval
- Allow the bank to foreclose on the home
Foreclosure is obviously the choice of last resort, which we’ve written about extensively at Lawyers.com. Assuming you can afford to pay the mortgage on your under water home, you’ve probably wondered whether you should stay in your home or try to sell it at a loss. This article explores both of those options.
Staying in Your Home
If your home is under water, you need to ask yourself: Does it matter? If you like your home, can continue to make the mortgage payments and think that your home’s value will eventually increase, it may not matter to you.
Some things to consider:
- Do you think your home’s value will increase within a reasonable period of time? The definition of "reasonable" will vary from person to person. If you’re content to live in your home for another 20 years, your timeframe is very different from someone who knows he will have to move within 3 years.
- What caused the drop in your home’s value? Not surprisingly, most homes in the US depreciated in value within the last several years because of the overall decline in the US economy. If that’s the major factor that affected your home’s price, you can probably expect the value to gradually increase in the future. On the other hand, if your home also fell in value because a nuclear power plant was built a block away or a fault developed in your front yard, that may permanently diminish your home’s value.
- Do you think there’s a chance your home could further decrease in value? If you’re torn between staying and moving, you also want to consider the worst-case scenarios. What happens if your home’s value falls further? How likely is that possibility?
Selling Your Home
When you sell your home at a loss, it is known as a short sale. You’ll want to talk to your bank before entering into a short sale, and they need to answer a very simple question: If you sell your home for a loss, how much money (if any) will you owe them? That’s because you’re typically expected to settle your outstanding mortgage when you sell your home.
Suppose you have a $100,000 mortgage. If you sell your home for $120,000, you pay the bank $100,000 and keep $20,000 in profits. But if you sell your home for $80,000, the bank may still expect you to pay them $100,000. You’ll either have to work out a payment plan with the bank or, in some circumstances, the bank may be willing to forgive the remaining debt.
In some circumstances, a short sale will still make sense, even if you still owe money to the bank. Suppose you’re paying $3,000 a month in mortgage payments and property taxes. You sell your home at a loss and negotiate a plan to pay the bank $250 a month on the remaining debt. You then rent a home for $1,500 a month. You’ll still only be paying $1,750 a month compared to the $3,000 you were paying.
There are a few instances where you should consider a short sale:
- If you see no signs that housing values in your neighborhood will improve within a reasonable amount of time
- If you think housing values might even decline in the future when you need to sell
- If you know you must sell your home within the next couple of years regardless of home prices
- If you can’t afford to continue making mortgage payments but don’t want to go into foreclosure
- If your bank is willing to forgive the outstanding debt after the short sale
In addition to talking to your bank, you should discuss the issue with real estate, legal and tax professionals to ensure that you fully understand the legal and financial ramifications of a tax sale.
Current Market & Future Predictions
According to current estimates, about 20 percent of US homeowners are under water. Nevada has the most homes under water (about 67 percent last fall, according to CoreLogic) and the most foreclosure filings. Oklahoma, New York, Pennsylvania, North Dakota and Montana have the fewest homes under water (between 6 and 8 percent of homes in those states).
According to Morgan Stanley estimates, home prices nationwide will probably continue to decline through the spring of 2012 before they bottom out and start to rise again.