Selling a house is already complicated, and it becomes even more so when the mortgage amount exceeds the home’s value. This is commonly known as being “underwater” or upside down on a mortgage. Several financial and legal aspects should be considered. Knowing what happens if you sell your house for less than you owe will help you make smart decisions and can save you from financial pitfalls.
Understanding Negative Equity
Negative equity occurs when the mortgage balance is more than the current market value of the property. This usually happens because of a fall in property values, recession, or buying a home with very little down payment. Hence, homeowners are in a bad position in case they have to sell the property. It becomes somewhat essential to look for feasible alternatives.
It is the short sale which is probably the most common fix for those homeowners who need to sell a property and find that the left value is negative home equity. The lender agrees to take a sum less than the full loan balance and accept that as payment in full in this case. Then obviously, the short sale has to be lender-approved because banks and mortgage companies have to find that most financially beneficial compared to foreclosure proceedings.
Steps Involved in a Short Sale:
- Financial Hardship Assessment – Lenders want documents certifying that some sort of Actual Financial Hardship is on the account of the homeowner, which includes loss of employment, medical expenditures, or other financial burdens.
- Contact the Lender- When you may have to take a short sale, it would help ease financial burdens when you tell your lender about it.
- List the Property – Go to a registered real estate agent who understands short sales and price the property competitively.
- Submit a Short Sale Package – Submitting a Short Sale Package typically involves the submission of the hardship letter, financial statements, and the purchase offer to the lender.
- Await Lender Approval – The lender will conduct its due diligence and determine whether it will approve the sale.
- Close the Sale – If approved, the proceeds from the sale go to the lender; the remaining mortgage may or may not be forgiven, depending on laws in that state and lender policy.
Consequences of Selling at a Loss
Homeowners may sell their houses at a price lower than the mortgage amount without any lender’s approval for a short sale; however, they will continue to be liable for the deficiency balance, which is the difference amount. Such deficiency balance may:
- Credit Score Effect- The lender forgiving part of the amount will be reported as a settled account, and that will harm your credit score.
- Deficiency Judgment- Some states allow the lenders to sue for the remaining balance, which means you would be liable for the shortfall legally.
- Problems Obtaining Future Loans- A history of forbearance might make lenders apprehensive about approving any future mortgage applications.
- Loss of Equity and Investment – Selling below a property’s market price means that you will not be able to recover those costs if you heavily invested in the property in renovation and upgrading.
- Emotional and Financial Drain – Selling a house at a price less than what you owe can turn the tides of a long-term financial plan and lead to finances and emotional drain.
- Tax Implications on Forgiven Debt – The IRS considers tax income for forgiven debt, and that means it can consider it taxable income based on the financial situation of the person.
Deficiency Judgments and Tax Implications
In some states, if they so wish, lenders can file a deficiency judgment against homeowners to pursue collection of the unpaid loan balance after a short sale. However, certain states possess anti-deficiency laws that safeguard homeowners against such judgments.
At the same time, owners must know the tax ramifications. The IRS looks at forgiven mortgage debt as income unless the homeowner qualifies for an exemption under the Mortgage Forgiveness Debt Relief Act.
Alternative Solutions
If selling the house at a loss doesn’t work, homeowners have other options to explore. For instance, loan modification is one, where they negotiate with lenders for new terms so that they can lower the monthly payments and make remitting it easier. Another option would be to rent the house. In this way, while waiting for the mileage to increase, the mortgage payment can be paid by rental income. Finally, refinancing becomes a good option if the homeowner meets qualification criteria for lower interest rates or government assistance programs and is therefore a boon towards less financial stress and sustainable homeownership.
Selling a home for less than its mortgage debt can have deep financial ramifications; thus, being educated about the available options would help minimize the damage to homeowners. Careful planning becomes vital concerning a short sale, negotiating with lenders, or any other options. Consulting an advisor before making a weighted decision is advised, as this whole process can get complicated for the layman.
Ultimately, knowing what happens if you sell your house for less than you owe allows homeowners to take proactive steps toward financial recovery and stability.