Chapter 4: Secondary Options for Consideration
It is important and realistic to consider other options if you cannot afford to or don’t really want to keep your home. This could occur when your situation changes so much that you cannot make the payments that you have been making. It can also occur when there is no equity in the property. Suppose you bought your home in 1990 for $158,000 and today your mortgage balance is $148,000. A realtor informs you that the value of your home has declined to $140,000, you might decide not to keep it.
- Foreclosure: You may decide not to, or may not be able to, make any more payments. When this happens, the lender will foreclose and take your home. The amount of time this takes varies from state to state. In California, this process takes approximately 4 months from the recording of the Notice of Default (see Foreclosure Timeline for California).
Some states allow the lender a deficiency judgment for the difference in value between the mortgage balance and any loss the lender might suffer where property values have declined. In California there is no deficiency judgment allowed on foreclosure of purchase money mortgages (the one you use to buy your home) but there may be deficiency judgments on refinanced home loans, VA loans, or junior lien loans (2nd mortgages). Deficiency judgments are very rare.
Deed in Lieu of Foreclosure: This option, which must be done with the lender’s permission, means you deed your home back to the lender. This saves the lender money and time and you avoid having a foreclosure on your credit report.
Short Sale (Pre-Foreclosure Sale for FHA-insured loans): In this case you will petition the lender to allow you to sell the house at its current market value which is less than the loan balance. If the lender agrees, you can enlist the aid of a realtor and try to sell your home even though the purchase price will be less than the outstanding balance. A lender may agree to a short sale because if the property is foreclosed upon, the lender will have to sell the house anyway. With a short sale, you save the lender time and foreclosure expenses by finding someone who wants to buy your house.
Your choice of how to handle your delinquency may affect your credit report. A foreclosure will remain on your credit report for 7 years. If you choose to let your home go back to the lender through foreclosure, you should keep accurate records of your attempts to resolve the problem. Assuming the rest of your credit is good, you should be able to buy another home in 2 years. If you choose deed-in-lieu or short sale, negotiate with the lender to re-age your credit report to remove the derogatory information and bring your account current.
Be sure to consult a tax specialist to discuss the tax implications of whatever option you pursue. In foreclosure, there are usually no tax implications other than possible capital gains if you have owned a home before and have rolled your gain into the property being foreclosed. When you use a deed-in-lieu or short sale and there is negative equity, you may be responsible for ordinary income taxes on the amount of the debt that the lender forgives (difference between your mortgage balance and the value of your home). Please check with your tax specialist.