Comparing Loan Modification, Short Sale, and Foreclosure

Comparing Loan Modification, Short Sale, and Foreclosure

By: Richard E. Korb[1]

©2010 RICHARD E. KORB

With unemployment rates remaining high and the economy struggling to recover from the great recession, many Americans are stuck in a daily struggle to meet mortgage payments and keep their homes. While foreclosure is considered the standard means for dealing with delinquent payments, you should be aware that other, better options may exist for you if you are one of the many dealing with financial struggles. This paper will briefly examine the process of foreclosure and why it should be avoided if possible before introducing two alternative options to foreclosure—loan modification and short sale.

Foreclosure

Foreclosure is the process by which your lender (typically a bank) sells your home when you fail to meet payments. Money made from the sale of your home goes to pay off the lender, then to any additional parties owed money, and finally, if there is excess, to the evicted borrower. However, one should keep in mind that with the depressed housing market, it is very unlikely that the sale price of your house will exceed the amount of your debt—meaning you will be unlikely to receive any money.

Unlike the two alternatives to foreclosure, this method of removing your debt is forced by the lender and requires no agreement between you and your lending institution beyond the loan documentation you originally signed. Once you become delinquent on payments, or default on your loan, your lender has the legal basis to begin the process of foreclosure. This can either be carried out via judicial foreclosure or foreclosure by power of sale or non-judicial foreclosure.

The primary distinction between these two types of foreclosure is that in a judicial foreclosure there will be a short court proceeding and the court will oversee the sale of your house. A non-judicial foreclosure, on the other hand, is where the property is sold directly by the mortgage holder without the oversight of the court. Because court is avoided, non-judicial foreclosures are usually much cheaper and faster processes for all parties involved. However, non-judicial foreclosure is only an option if your mortgage is really a “deed of trust”.

Aside from the emotional stress that can accompany the process of foreclosure, one of the biggest negative impacts is the result it will have on your credit score. Record of foreclosure will make it harder for you to get loans in the future and will likely lead to higher interest rates demanded by banks as they will perceive loaning to you as more risky.

Fortunately there are two alternate options that may be available to you if you are having difficulty meeting payments and are worried about a possible foreclosure. With either of these options, you avoid scarring your credit score with the record of a past foreclosure. However, both options require that you reach an agreement with your lending institution.

Short Sale

In a short sale, your bank agrees to allow you to sell your house for less than the amount you still owe on your loan.  Lenders may agree to short sales if they believe that letting you sell your house for an agreed upon price will result in losing less money overall than waiting for you to make payments or having to pay for the process of foreclosing upon your home themselves.

The difficulty of achieving the negotiation of a short sale with your bank is, of course, that you need to have an offer on your home that meets the banks standards before you can really begin negotiating the possibility of the bank allowing the short sale. Moreover, you probably won’t be able to negotiate a short sale if you have multiple lenders, such as home equity lines of credit etc., because these secondary lenders are not likely to benefit from the sale.

If a short sale is a possibility for you, there are two important details that you should keep be aware of. To begin with, the difference between the amount that you owed on your loan and the amount you pay the bank from the short sale will be treated as income and you will be taxed.  You can avoid being taxed on the deficiency amount if you can prove to the IRS that your total debt was greater than your total assets at the time of the short sale.

This is referred to as being legally insolvent. Finally, in negotiating with your lender to reach a short sale, be sure that agree to accept the offered sale price without seeking a deficiency judgment. If you do not make this stipulation clear, there is the possibility that the lender could go back on the agreement and sue you for the amount that you still owe. If this “deficiency judgment” were to take place, it would negatively affect your credit score.

Loan Modification

If short selling is not an option for you or you want to attempt to keep your home, you may be able to figure out a more affordable payment schedule with your lender through the process of loan modification, which can either mean extending the term of your loan or reducing the amount of principal or interest that you must pay.  The ability to refinance will vary from lender to lender, but recent legislation, such as The Homeowner Affordability and Stability Plan, has made it easier for certain people to qualify for modification, especially if your loan is owned by Fannie Mae or Freddie Mac. If you are hopeful that your financial situation will improve in the future, modifying the structure of your payment schedule can be a way to reduce stress in the short run and work to keep your home.

[1] RICHARD E. KORB is a seasoned attorney (and a Cal/Hastings Alum) with 30 years of legal experience in business, real estate, contracts, bankruptcy and more. Over his legal career, Richard has successfully litigated, negotiated and resolved over 300 cases for individuals and companies of all shapes and sizes. Richard leverages his experience to assist individuals and small-to mid-sized companies with a broad spectrum of legal matters.  In addition to his legal practice, Richard is also court-approved mediator and serves on the Alternative Dispute Resolution (ADR) panel for both the Alameda and Contra Costs County Superior Courts. ©2010 RICHARD E. KORB.