Short Sale or Foreclosure?

UpdatedJul 16, 2009

I can't afford to make my house payments anymore. What are my options?

I have a big problem with my house. I bought a house more then 4 years ago, but now I can't afford to pay my payment. My question is what is the best way to handle this (short sale or foreclosure)? If I foreclose do I have to pay something like 1099 IRS? Thank you very much for helping me.

Editor’s note: See the Bills.com resource Home Affordable Foreclosure Alternatives Program for an updated discussion of deeds in lieu of foreclosure and short sales.

Generally speaking, allowing a home to go into foreclosure is not a good idea for consumers, as you will lose any equity that you have built in the home and take a terrible credit impact. In some cases, though, consumers have no choice but to allow a foreclosure to proceed.

The easiest way that you can free yourself of this obligation without owing a deficiency balance is through a "short sale," in which the mortgage holder agrees to accept less than the balance owed on the mortgage at sale to prevent foreclosure. The lender would much rather see you sell the property than be forced to take the property through foreclosure, as foreclosure is a costly and time-consuming process. You should contact your mortgage lender to discuss what it can do to assist you in selling the property through a short sale, and what are its procedures and requirements. Explain to the lender that you cannot afford your mortgage payments, and that you need to sell the property through a short sale to prevent foreclosure.

If the lender will not allow you to sell the home for less than you owe, you may have no choice but to allow the home to go into foreclosure, although foreclosure presents major problems. Foreclosure auctions tend to bring significantly less money than a normal sale would bring. If the sale brings less than the amount owed on the loan, the remaining balance of the loan may be considered a deficiency balance. Clearly foreclosure is not an attractive option, and should be avoided if at all possible.

If you have no choice but to allow foreclosure, you may be able to mitigate the negative impact of a deficiency balance by filing bankruptcy. Generally speaking, deficiency balances are treated like any other unsecured debt in bankruptcy, meaning they can be wiped clear by Chapter 7, and repaid over time through a Chapter 13. If your lender will not allow a short sale, you should consult with an attorney to discuss the legal implications of foreclosure and bankruptcy before you decide how to proceed. No one wants to file bankruptcy, but you may find that bankruptcy is the best solution to your problem if the mortgage lender will not allow you to sell the home through a short sale.

To read more about foreclosure, I invite you to visit the Bills.com Foreclosure Information Page. Also visit Bills.com to get a Free Mortgage Refinance Quote.

IRS 1099-C

Regarding your question about the 1099, the IRS treats a foreclosure as a home sale, with any forgiven debt treated as regular income. Reporting a gain or a loss on the sale/foreclosure will depend on whether you are personally liable for the debt (which is normally determined by state law where the property is located). There are exemptions and state laws to take into consideration as well, so you should consult with a qualified tax adviser or tax attorney in your state and find out how they apply to your specific situation.

I will provide you with a links that should help educate you on foreclosure, taxes, and instructions on 1099-A forms. This may help you to head into your meeting with your tax adviser or attorney with some understanding of the basics involved.

I hope this information helps you Find. Learn. Save.

Best,

Bill

Bills.com

6 Comments

BBill, Jan, 2010

Short sale is preferable to foreclosure. Generally speaking, the deficiency balance is forgiven in a short sale, though some Bills.com readers have reported that banks are adding language to short sale documents that would require the homeowner to be liable for the deficiency balance. If your lender places such language in your short sale document ask them to remove it. If you are in doubt about the language in your short sale documents, I urge you to consult with an attorney in your state who has experience in property law.

MMKnowles, Jan, 2010

I am currently in our second year of being discharged from Chapter 7. Within this bankruptcy we let go our two condo that we owned. SInce the discharge, the bank has still not foreclosed on the properties. Now there is someone that is asking if we want to short-sale the properties. I think that it would better in the long run on our credit (I kow we already have been hit with the bankruptcy). The thing I worry about is if we will be responsible for the difference in the amount owed versus the sales price. We live in Florida. Please advise.

BBill, Sep, 2009

Under federal law, a lender must report to the IRS any forgiveness of a debt in an amount larger than $600. Borrowers are required to report this amount on form 1099C when they file their income taxes. However, the Mortgage Forgiveness Debt Relief Act exempts borrowers from the tax liability that would otherwise be created by a lender forgiving a portion of their loan balance, either in a short sale, loan modification, or as the result of a foreclosure on their primary residence. Read the link I referenced to see if they can make an argument that the NV property was their primary residence. I can appreciate your wanting to be with your parents when they speak with an attorney. The next best thing would be for you to ask a Washington bankruptcy attorney to conference-call you in on the meeting with your parents. Attorneys are notorious for being Luddites. Some, however, acknowledge the Internet's existence, and if you are lucky you may find a bankruptcy attorney you and your parents like who has a Web cam on his or her office computer that would allow you to see, hear, and participate in the meetings.

HHelp for parents, Sep, 2009

My parents own a primary residence in Washington State and purchased a home in Nevada a second home with the intent to sell thier primary and move to Nevada and retire. Through a hardship beyond thier control they couldn't sell their WA home and could no longer make the payments on the NV home. They were talked into short sale. They now have a buyer and the bank just agreed on a short sale, they are due to close at the end of the month but having cold feet because I started looking into the the tax implications and it appears they will only be insolvent for a portion of the gain which will mean they will owe the IRS $48,000. After learning this I started looking up Bankruptcy for them and it appears they will more than qualify for Bankruptcy but I am wondering which would be better, should they foreclose or short sale before a bankruptcy? They don't have to move forward with the short sale they can let the house go if that will be the better direction, I just don't know since I live in NV and they are WA residents... it is tough for me to seek legal advice over the phone. My parents are concerned, don't know what to do and don't want to visit an attorney without me.. I can not get out to Washington until the middle of October - AFTER the scheduled sale. Can you help in this situation or point me in the right direction?Thank you

BBill, Aug, 2009

First, go to the Home Affordable Refinance Program Web site to see if you qualify for this program. An option, as you suggest, is a Chapter 13 bankruptcy. If at all possible, stop a foreclosure.

NNb05, Aug, 2009

I'm upside down on home, and no longer have overtime as an option to help in paying the mass debt accumulated. I've talk to mortgage lender is no longer "refinances" so that I can receive a lower monthly payment, and because I am "upside down" no want else will even assist with bill consolidation. Other than the house, I have a beat up car (can't afford to make payment on a new one). What are my options? Do I let my home go into forclosure, or file chapter 7?