Short sale is a good option to avoid foreclosure, however if you don’t know what you are getting into, you may end up owing a deficiency judgment unless it is otherwise stipulated in the short sale agreement.
What is short sale: A short sale is a sale of real estate in which the sale proceeds fall short of the balance owed on the property’s loan. Both parties consent to the short sale process, because it allows them to avoid foreclosure, which involves hefty fees for the bank and poorer credit report outcomes for the borrowers. This agreement, however, does not necessarily release the borrower from the obligation to pay the remaining balance of the loan, known as the “deficiency.”
What is a deficiency judgment: A deficiency judgment is simply the difference between what the lender is owed and what they are paid back. When a lender is not paid back in full via a short sale, they can go to court and get a court order directing the borrower to pay them back the difference. The lender can then take that judgment and attach it to the borrower’s other properties, if they have any, or garnish the wages of the borrower.
In the State of Washington deficiency judgments are not permitted on non-judicial foreclosure processes, however, if there is no “power of sale” clause present in the original loan documents, the lender can pursue judicial foreclosure. The lender would have to sue the borrower to start a judicial foreclosure and a deficiency judgment can be awarded to the lender if the property is found by the court to have been abandoned for at least six months before the decree of foreclosure. If the “power of sale” clause is present in the original loan documents, the lender can pursue non-judicial foreclosure. This clause authorizes the lender to sell the property in the event the borrower goes into default on the loan.
The non-judicial foreclosure process in Washington State does not allow for the lender to sue the borrower to obtain a deficiency judgment. In real life it’s rare for the lender to foreclose judicially because Washington is a redemption state. Also, if the homeowner doesn’t have equity in the property, and they do not have other assets the lender can go after, they usually don’t attempt to obtain a deficiency judgment. It’s not to say they won’t try, but it is usually to their advantage to just get the house sold with a short sale and write the loss off and move on.
So are we safe from deficiency judgments in Washington State? No.
In Washington, the lender gives up the right to a deficiency judgment if they sell the property or take it back in the non-judicial trustee sale process. However, because a negotiated short sale closes in lieu of a trustee sale, the lender preserves their right to get a deficiency judgment.
You can basically tell the lender that the borrower will simply allow the house to go to sale if they don’t remove the deficiency language in the payoff. Simply cross out the deficiency language and send the payoff back to the negotiator.
Another strategy is to always include language in the Purchase Sale Agreement stating that the sale is contingent on the bank approval and each lender’s waiver of any rights to a deficiency.
So if you short sell, be sure your lender gives up their right to collect a deficiency judgment. The lender will then send you a 1099 form notifying you of the deficiency forgiven which in turn needs to be reported to the IRS as “unearned income.” If this is done before 2012, you can be exempt from paying taxes on this 1099 under the Debt Relief Act of 2007.
So, is it a good idea to short sell a house even when you are not at risk of foreclosure? Yes, if you are “underwater” or your loan is “upside down” (you owe more than what the house is worth), you are basically paying a very expensive rent to just live in your house. These loans cannot be refinanced because lenders require at least 80% loan-to-value ratio (LTV) to refinance your loan. If you are in this situation, then consider short sale as an option to get out of this negative investment.
The Making Home Affordable Program launched by President Obama in March of 2009 was designed to help responsible homeowners rectify their loans into more favorable terms. Unfortunately, this program has only been able to help 21% of eligible homeowners, and there are many other homeowners still facing foreclosure who don’t qualify for a loan modification.
Talk to a HUD-certified Mortgage counselor to review your options and avoid foreclosure. While a counselor cannot guarantee you get a loan modification, they can evaluate your situation and go over your options to prevent foreclosure.
To find a HUD-certified counselor in your area you may visit HUD’s website at www.HUD.gov.
To speak to a Housing Counselor at Solid Ground, call the hotline at 206.694.6766, open Mondays and Wednesdays from 7 AM until 4 PM. Or you can complete our Mortgage Intake Form online.
Our counselors at Solid Ground are not attorneys and cannot provide legal advice. If you have legal questions, please contact the Northwest Justice Project at 206.461.3200 or the Washington State Bar Association at 206.443.9722.
Holly Hochstadt says
This is a great piece… lots of good and current info, and links. I would love to see it expanded to include the 2 lender scenario…. more complicated, but VERY common.
My website is just informational but from what I have seen the short sale situation is just getting worse. Today in court there were 63 conferences and that was the afternoon calander. We have to do something to help both the US and homeowners get past this ugly situation caused by greed and coruption.
Great Blog Post.
I am in the position where I’m not at risk of forclosure, but I’m upside down in my mortgage, with no light at the end of the tunnel. I have a lawyer that is really pushing to do a short sale, but I have concerns about it crushing my credit score. I am also concerned with being liable for the deficiency. You talked alot about the latter, but what about what a short sale does to your credit?
Gordon Stephens says
I’m a R.E agent but quote Attorney’s Title a law firm in Tacoma who contrast effect on Credit by Foreclosure Vs Short Sale. In a Foreclosure “Score may be lowered anywhere from 150 to over 300 points. Typically, this will affect score for over 3 years and remain as a public record on your credit history for 10 years or more.” In a short sale “Only late payments on mortgage will show and after sale, mortgage will be reported as paid or negotiated. This will lower the score as little as 50 points, if all other payments are being made. A short sale’s effect can be as brief as 12 to 18 months.”
In my case I did a short sale 4 years ago. Now the second lender wants their money.
I have a home worth about $290,000 with a first of $245,000 and a second (heloc) of $100,000. Total loans of about $300,000. Its rented out for $1900/month.
How do I get out of this without a deficiency judgement. Im 77yrs old.
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