Many clients of ours often ask whether selling a home in a short sale is a good idea, either with a bankruptcy case planned or while considering non-bankruptcy alternatives. It is almost always the case that a client’s bankruptcy options are superior to those derived from a short sale, but there are situations in which it benefits a client to at least communicate with creditors regarding a short sale, even if no short sale is eventually completed.

The simple definition of a short sale is a sale in which you sell your home for less than the amount of money you owe to all of your creditors on the property. Short sales require the consent of all lenders, lien holders, and other secured creditors who you owe a debt to secured by your house, and unanimous consent must be obtained. In other words, every creditor you owe money to that is secured by your home must agree to a short sale, and on properties with multiple creditors holding liens, this can be a very challenging goal, particularly where there are multiple mortgages on the property.

For example, if you own a home that is currently worth $600,000, and you owe your first mortgage company $800,000 and your second mortgage company $200,000, then your home cannot be sold for at least the value of the debt that you owe on it. In this situation, if you wanted to sell your home, maybe because you can’t make the payments on the house, you could consider a short sale, if you could obtain the permission of every lender who loaned money to you on the property. In the situation above, to sell your home in a short sale, you would need to convince the first lender to accept only $600,000 for its claim of $800,000 on the property, and somehow obtain the approval of the second lender, even though that creditor would normally get nothing, as there is no money from the sales price that can be used to pay them if the home sells for $600,000. When a second lender does approve a short sale transaction, it is often because either the first lender or the seller has agreed to compensate them in some way, for example, by paying the second lender $5,000 to approve the short sale and waive the remaining $195,000 ($200,000-$5,000) of the second lender’s claim. If unanimous consent from all lenders is obtained, then the property can be sold through a short sale, if there is a willing buyer for the property.

It is the opinion of Nova Law Group that short sales almost never benefit the client, but there are circumstances where merely talking to lenders about a potential short sale might be. For many clients, merely discussing the possibility of a short sale with a lender might buy the client months of living in the house without the lender moving toward foreclosure, as some lenders figure that foreclosure is not cost-effective if you are willing to sell your home to a qualified buyer anyway. This can benefit a client, because it basically means that while your realtor or the lender attempts to find a buyer, you may get to live in the house free of charge, possibly for months or even years. This is particularly true where real estate has dropped significantly, because there may not be many buyers looking to purchase property and it may take a long time for the lender or your realtor to find a buyer, giving you more time in your home. This is of course only true if your lender is willing to stop all foreclosure proceedings during the negotiation of the short sale. Without this, there is really no benefit to the client in talking with them.

While talking with a lender about a short sale can sometimes be beneficial to a client for the reasons stated above, actually completing a short sale is rarely, if ever, a good idea. While the list of reasons why a short sale is generally a terrible option for clients is too large and complex to put in one blog post, some of the biggest reasons are discussed below.

First, when you complete a short sale, you often lose the home right away, or within about a month of the time the transaction is completed. Losing the home quickly in a short sale to a buyer means that you can’t live in the property free of charge, for months or even years on end, because you have voluntarily given it up. For example, if you agree with a lender to do a short sale, and the lender finds a buyer within 2 weeks for your home at a tremendously reduced price, then you might need to leave your home in a total of 6 weeks or so, when the deal closes and the right to possession of the property is transferred. In contrast, if you were to simply do nothing at all and let the lender evict you, you would get a minimum of 90-180 days in your home during the notice of default period (depending on the applicability of Cal. Civ. Code Sections 2923.52, 2923.53), and then another 20 days during the notice of sale period, resulting in a total time in your home of 4-7 months. Additionally, it often takes the foreclosure department of a bank a lot of time to get its act together and actually commence foreclosure proceedings, meaning additional time living in your home free of charge. As a result, it is almost never a good idea to effectuate a short sale on your home, because it deprives you of the ability to live in your house for many months or years free of charge, allowing you to save a lot of money for a subsequent move or other purposes.

Second, it is sometimes the case that a lender will sue you after selling your home in a short sale, for the amount of the difference between the money you owed them and the amount they received in the short sale for the property. This occurs regularly, even in situations where the lender can’t legally sue you, because the lender hopes that you’ll be too broke to hire an attorney to defend your rights, and that they will get away with obtaining a judgment against you for the deficiency as a result. Some deficiency judgments can be for several hundred thousand dollars, and while a short sale does not ensure that you won’t be held responsible for a deficiency judgment, bankruptcy almost always does. Additionally, don’t simply take the lender’s word that they won’t sue you for a deficiency judgment after completing a short sale, as many lenders are not honest with their former clients in this regard. All short sale agreements should be reviewed by a competent attorney to ensure that there is no liability on the client’s part after the short sale. However, it is the opinion of Nova Law Group that a short sale should never be done at all.

Third, many people consider a short sale even on a home they would like to keep, simply because they can’t afford the full payment on the home, or can’t afford to bring the back payments (arrearage) current. At Nova Law Group, we encourage our clients to evaluate whether a bankruptcy alternative might be a more powerful resolution to keeping a client’s home or resolving the debt, instead of completing a short sale that may be completely unnecessary. For example, it is possible in a Chapter 13 bankruptcy to force a secured lender to accept small monthly payments for the arrearage on your house, instead of a lump-sum payment as the lender often demands. In a hypothetical situation where you owe $60,000 in back payments (arrearage) on your home, you might be able to force the lender to accept $1,000 per month over 5 years, instead of all $60,000 upfront, and keep your home instead of selling it. However, this strategy requires that the client be able to afford to make not only the small arrears payments each month, but also the full mortgage payment as well, although other creditors often do not need to be paid (like credit card debt and other unsecured debt). At the same time, making up the arrears is not the only way bankruptcy offers vastly more options to keep your home relative to a short sale, which often quickly disposes of it. For example, in a Chapter 13 bankruptcy it is sometimes possible to permanently remove a junior lien, like a 2nd, 3rd, or 4th mortgage from your home permanently, which often means you never need to pay on the loan ever again. This allows some people who can afford the first mortgage, but not the second or any subsequent mortgage, to strip those liens permanently off the property and keep their home in the process.

In essence, bankruptcy offers many opportunities that simply don’t exist in a short sale to either keep your home, or to live in your home free of charge for as long as possible, saving money in the process. If you are in a position where you are facing foreclosure, Nova Law Group encourages you to consider bankruptcy options in addition to options regarding a short sale, as it is our opinion that bankruptcy is generally a far superior alternative. Although it may sometimes benefit a client to “talk” about a short sale with a lender, it almost never makes sense to actually complete a short sale transaction, and at Nova Law Group we advise our clients accordingly. If you would like to explore bankruptcy options as they might apply to your individual situation, a Nova Law Group attorney would be happy to assist you.