Short sale may not kill new-home dreams

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Dear Dr. Don,
I am considering a short sale on my house. I am upside down about $2,000 a month on a $3,500 a month mortgage. Working with the bank for a workout package has been fruitless.

My income has gone from about $200,000 to $85,000 and is deemed “deficient” by the mortgage company. If I go through with a short sale, do I have any chance of buying a home again in the near future?
— Ben Buyer

Dear Ben,
If you were working with your lender through the Home Affordable Modification Program, or HAMP, you may be able to participate in the Home Affordable Foreclosure Alternatives, or HAFA, program.

The Bankrate feature “HAFA short sale rules may help sellers” provides additional details. So does the government Making Home Affordable website on its “Borrower frequently asked questions” page.

In a short sale, the lender agrees to accept an amount less than the loan balance on the sale of a property. By doing so, the lender avoids having to foreclose on the property.

The ideal short sale is nonrecourse to the seller, meaning the lender can’t pursue the borrower for the deficiency. It’s a home run if the lender doesn’t report it on the seller’s credit report.

Some states allow the lender to pursue recourse for the nonpayment on the debt, while other states don’t allow the lender to pursue recourse for nonpayment of a purchase money loan. A state that uses nonrecourse rules for a purchase money loan may, however, allow recourse on a refinancing.

Another concern with a short sale is whether any money forgiven by the lender is considered taxable income to the seller. The Internal Revenue Service provides some guidance here in its online publication “The Mortgage Forgiveness Debt Relief Act and Debt Cancellation.”

As you can see, there’s a lot going on here legally. I recommend you get professional legal advice before deciding to try to sell your home on a short sale. Take a look at the Bankrate feature “Risks of walking away from mortgage debt” for additional information.

The bank has to buy in to the idea that it’s better off with the short sale than it would be by keeping you in the house. You typically have to show financial hardship and that you are unable to keep up with the payments.

Often, a lender won’t sign off on a short sale if the borrower is current on his or her payments. Those late pays hurt your credit score and can limit your ability to get a mortgage on a new home. For example, under Department of Housing and Urban Development guidelines in Mortgage Letter 09-52, borrowers are considered eligible for a new mortgage insured by the Federal Housing Administration if:

  • They were current on their mortgage and other installment debts at the time of the short sale of their previously owned property, and
  • The proceeds from the short sale serve as payment in full.

On the other hand, borrowers are not eligible for a new FHA mortgage if they pursued a short sale agreement on a principal residence simply to:

  • Take advantage of declining market conditions, and
  • Purchase, at a reduced price, a similar or superior property within a reasonable commuting distance.

In addition, borrowers in default on their mortgage at the time of the short sale, or preforeclosure sale, are not eligible for a new FHA-insured mortgage for three years from the date of the preforeclosure sale. Lenders may make exceptions to this rule under certain circumstances.

You didn’t mention that you’re considering FHA financing, but conventional financing will have similar mortgage lending considerations and may put you in the penalty box for less time than the FHA.

Once you’re out from under the original mortgage, you need a new place to live. A rental is the likely first move, as you wait for your credit score to improve, unless you were lucky enough that the short sale didn’t impact your credit and you have the income to qualify for a new home.

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